Summary of Key Points
The May U.S. non-farm payroll data far exceeded expectations (an increase of 172,000 jobs, the largest three-month gain in over two years), completely shifting market expectations regarding Federal Reserve (Fed) policy: What was once hoped for as a rate cut has now turned into bets on a rate hike. The bond market tumbled, and most Wall Street investment banks have abandoned their forecasts of a rate cut this year, even shifting to expect a hike, with only Citibank still insisting on three rate cuts within the year, becoming the “outlier.”
Detailed Analysis
1. Why Could Non-Farm Data “Subvert” Market Expectations?
The May employment data was like a “bombshell”: An additional 172,000 jobs were created, not only exceeding all economists’ forecasts but also representing the largest three-month increase in over two years. What does this indicate? The job market remains robust—people have jobs and money to spend, making it difficult for prices to fall (inflationary pressures will persist). Previously, the market thought the Fed might cut rates to stimulate the economy, but with such strong employment and no reduction in inflation, there’s no need for a rate cut; instead, a rate hike may be necessary to curb inflation. This data shattered any remaining hopes of a rate cut, completely changing market sentiment.
2. Market Panic: Bond Prices Plummet, Hike Expectations Soar
As soon as the employment data was released, the bond market collapsed: Rate hikes would lower the interest rates on existing bonds, leading to a frenzied selling of bonds. The yield on two-year U.S. Treasury bonds rose by 15 basis points (0.15%) in one week, while that on three-year bonds only rose by 3 basis points—this is because two-year bonds are more sensitive to short-term interest rates, and traders are more concerned about an imminent rate hike. Traders used the “interest rate swap market” to bet on rate changes; now they firmly believe a rate hike will occur in December this year, with a 60% chance of one occurring in October. A manager at BlackRock said, “It’s the market driving the Fed, not the Fed guiding the market.”
3. Major Wall Street Banks Change Course, Leaving Citibank Alone
At the beginning of the year, most major banks predicted the Fed would cut rates this year (mostly twice). However, with rising oil prices due to the Iran conflict, persistent inflation, strong employment, and record-high stock markets, these banks have reversed their positions: some have abandoned rate cut forecasts, while others are now predicting hikes. For example, JPMorgan Chase has been predicting a rate hike in 2027 since January, and BNP Paribas went even further after the non-farm data, suggesting three consecutive rate hikes starting in December this year. Only Citibank still insists on three rate cuts within the year, essentially being alone on this view on Wall Street.
4. Citibank’s “Confidence”: Past Performance + Employment Analysis
Why does Citibank dare to stand out? First, they believe the current strong employment is temporary and that the labor market will soften in the next three months (with fewer new jobs), leading the market to expect a rate cut again. Second, they have a track record of accuracy: Last year, when most others predicted no rate cuts by the Fed, Citibank accurately forecasted three 25-basis-point cuts, which has made their predictions more credible. Although they have moved the first rate cut from January to September, the core prediction of three cuts remains unchanged.
5. The Core Dispute: Does the Fed Focus on Inflation or Employment?
The current disagreement is about where the Fed’s policy focus lies:
- The market and most banks believe that with strong employment and high inflation, the Fed must prioritize curbing inflation, thus requiring a rate hike;
- Citibank believes that the strong employment is temporary, and once it weakens, the Fed will switch to supporting employment, which would necessitate a rate cut.
At the April Fed meeting, three officials opposed the notion of “dual risks from employment and inflation,” indicating that some officials are more concerned about inflation. This debate is not about when to cut rates but whether to hike them at all—a fundamental shift in direction.
Conclusion
The current standoff between the market and Citibank is essentially a judgment on the future economic trend: If employment remains strong and inflation does not subside, the Fed is likely to raise rates, putting Citibank’s predictions to the test; if employment weakens quickly and inflation eases, Citibank could once again prove its accuracy. The employment data in the next three months will be the deciding factor in this dispute.