MUFG said softer US labour data could prompt markets to reprice Federal Reserve policy away from further tightening and towards an increased risk of rate cuts. The bank pointed to weakening nonfarm payrolls trends, a deterioration in sentiment indicators and easing inflation risks, while expecting the Fed to remain on hold and the recent US Dollar rally to retrace.
MUFG referenced market pricing that had reached close to two rate hikes by March 2027 and argued June payrolls should act as a catalyst for a reassessment. It cited nine FOMC members previously indicating the need for at least one rate rise, while adding that inflation risks have receded over the last four weeks. Based on OIS pricing, markets still imply a 20% probability of a 25bp hike at the 29 July FOMC meeting and a 60% probability of a hike by September. The next major catalysts flagged were 14 July, when June CPI data and the semi-annual testimony from Fed Chair Warsh are due.
Market Mispricing And Fed Policy Outlook
We believe the market is mispricing Federal Reserve policy following yesterday’s weaker jobs data. The June nonfarm payroll report came in at only 110,000, well below the 180,000 consensus, and the unemployment rate ticked up to 4.1%. This data challenges the need for any further rate hikes that the market has been anticipating.
Given this, traders should consider positioning for a repricing in the rates market away from hikes. The OIS market still shows a nearly 60% chance of a hike by September, which we see as far too high. We are looking at derivatives like SOFR futures to capitalize on a shift toward the Fed remaining on hold or even signaling future cuts.
Dollar Outlook And Key Events Ahead
The US Dollar rally also looks exhausted and vulnerable to a retracement. The DXY index recently touched a multi-month high of 106.5 but is now showing signs of stalling as rate hike odds diminish. We view this as an opportunity to use options to position for dollar weakness against currencies like the euro or yen in the coming weeks.
Receding inflation supports this view, with the latest Core PCE data for May slowing to a 2.6% annual rate, moving closer to the Fed’s target. This pattern is reminiscent of late 2023, when markets quickly abandoned hike expectations, leading to a sharp dollar sell-off. The justification for a hawkish Fed stance is quickly fading.
Momentum is unlikely to shift back in the dollar’s favor before the next key events. All eyes are now on the June CPI data and Fed Chair Warsh’s testimony, both scheduled for July 14th. We expect these events will act as the next major catalyst to validate a softer Fed outlook.
