Will the Fed cut rates next week?

The weakness in payroll employment in recent months seems likely to push the Fed to a 25-bps rate cut next week; the first one of 2025. Of course, we also have to mention the suspicion that voting on the Fed will be a bit more politically motivated, especially given the likely arrival of White House economic advisor Stephen Miran as a Board member next week. It is also worth noting that inflation data has experienced little uplift as a result of tariffs compared to earlier concerns.

In addition, Fed members have hinted that they are prepared to look over the hump of tariff-induced inflation; a course that will be less controversial should the labour market continue to weaken. The market is priced for the Fed to keep going with rate cuts until the rate settles at, or slightly below, the FOMC’s median estimate of the ‘neutral’ rate, which is put at 3%, next summer. We don’t have a huge disagreement with this profile, but we do start to differ as we look out a little further, into 2027 and 2028.

For while market pricing seems to suggest the maintenance of a broad 3% fed funds target for as far as the eye can see, Steven Barrow, Head of Standard Bank G10 Strategy thinks that rates will start to go up again from the middle of 2027 and, by the end of 2028 will be at least a percentage point above the levels priced into the market. One reason relates to the weakness in the labour market. He has put weakness in italics because it is clear that, while labour demand is weak, as we see in payroll data, so too is labour supply, which is why the unemployment rate has hardly budged this year. The so-called breakeven rate of payroll growth, which is the rate of payroll growth below which the unemployment rate starts to rise, seems to have fallen substantially, much of which is due to President Trump’s tough migration policies.

“We think it unlikely that these policies will be eased and may well be tightened even more. The effective deportation of 300 workers at South Korea’s Hyundai’s plant in Georgia at the weekend may be a concerning sign that the illegal immigration screw could be about to turn a little tighter. The problem we foresee is that if Fed rate cuts, or other actions, such as 2026 tax cuts under Trump’s One Big Beautiful Bill, lift the demand for workers the unemployment rate could start to tumble unless labour supply keeps up. And given that the current unemployment rate of 4.3% is still only a tenth above the FOMC’s estimate of full employment, it won’t take much of a fall in the unemployment rate to get the Fed thinking about reversing 2026 rate cuts in 2027”, said Steven Barrow.

The second issue is inflation. So far, tariffs have not lifted inflation materially and that’s probably because firms are still using pre-tariff inventory as well as absorbing some of the tariff cost themselves. But in time these things are likely to change and in Steven Barrow’s view, there could be further pressure on the bottom line of firms if wage costs rise as a result of the restrictions to labour supply that we’ve just mentioned.

Another concern is that people’s memory of sky-high inflation from 2022 will stick with them for some time with the risk that inflation expectations will continue to run far ahead of the target. All these things will require the Fed to unwind the spate of rate cuts that seems likely to start from next week. Initially, the Fed will resist any such rate hikes and there will presumably be intense political pressure on the bank to hold back as the Administration readies itself for the 2028 presidential election campaign. But the Fed won’t be able to comply for long and, if that means that 2025/26 rate cuts are at least partially reversed in 2027 and beyond it suggests to us that those considering borrowing dollars over a long-term horizon may be best served by taking advantage of any reduction in the fed funds target to 3%, or thereabouts over the next 6-9 months.