Is the Fed about to make one other coverage mistake?

Since the softer than expected NFP report, Fed members started to line up for a September cut. Overall, the data wasn’t as
bad as one might think by just looking at the reaction but given that we were
positioned for a strong report and the pricing got more hawkish after the Fed’s
decision, the weaker data was enough to trigger a quick repricing.

In fact, the market is now
pricing 60 bps of easing by year-end compared to just 35 bps before the NFP
release. The pricing got also solidified by several Fed members opening the door for an imminent cut. We had Fed’s Williams, Fed’s Daly and Fed’s Kashkari all citing labour market weakness as the reason for pre-emptively cut.

Just before the NFP report, they were saying that they want to balance both sides of the mandate and that price stability was the one requiring more attention given that we are still much closer to 3% than their 2% target. Nonetheless, it took just one soft NFP to trigger a quick change of heart. Where’s the “rate cut at the next meeting will be decided by totality of the data leading up to it” gone?

I understand the market reacting and pricing expectations based on a single data point (that’s normal), but the Fed is overreacting much like the market, which could set them up for a policy mistake. If the labour market is actually fine and they cut, then there’s a high chance they will cut into a rebounding economy and increase the momentum.

We all know that tariff uncertainty kind of froze the labour market and other investments. That is now old news. We have certainty now about the tariffs and so on, and that could see businesses getting back to hire and invest more, especially with higher rate cut probabilities.

The US jobless claims have been showing a “low firing, low hiring” labour market and surveys like the PMIs have been citing high inflationary pressures. We still have jobless claims today and CPI next week that could change market’s expectations. Strong data is likely to trigger a more hawkish repricing, while weak data will reinforce bets for rate cuts and the probabilities for a third might increase further.

If the Fed continues with its dovish rhetoric despite stronger data just because of the NFP though, watch the 10 year Treasury yield as that will show you if the market is fearing a policy mistake. In fact, even if the Fed cuts, yields will likely rise (contrary to Trump’s thinking) as the market will price in a higher inflation premium.