A Hawkish December Fed Cut Would Be A Problem For Risk Sentiment

Authored by Michael Ball, Bloomberg macro strategist,

The Federal Reserve would confirm it prioritizes a fading inflation scare over weakening labor markets and tightening credit conditions with a hawkish December rate cut, unwilling to ease further until something breaks. 

This message would drag risk sentiment lower as markets reprice a Fed that’s making a policy error.

A December cut itself should be an easy call.

The unemployment rate has risen for three straight months and now sits in the mid-fours and there are increasing signs of more layoffs in the pipeline.

Wage momentum is also cooling, according to Indeed Wage Growth Tracker, not re-accelerating.

Hours worked are flat even as GDP readings remain suspiciously strong — a mix that usually ends one of two ways. Either productivity suddenly surges in a weakening labor market, which would be unusual, or far more likely growth slows to line up with the softer labor data.

On top of that, credit is tightening for households and small firms, with the latest New York Fed survey showing rejection rates for loan applications at a new series high across mortgages, autos and refis.

None of that looks like an economy that needs patience given the already restrictive policy stance.

Inflation, meanwhile, isn’t giving the hawks the cover they claim. Tariffs are now in place, but headline numbers overstate future pressure. Rental inflation is cooling, which is what matters for the core trend.

Business inflation expectations are unchanged from a year ago. Firms — the price setters — are telling you they don’t plan an aggressive round of price hikes, and wage growth in the sectors most exposed to immigration enforcement and cost shocks remains subdued, capping cost increases, according to research from Renaissance Macro. The inflation gap is not widening, while the unemployment gap is.

Yet the policymaker “vibes” skew the other way. The minutes framed “many” participants as preferring to keep rates unchanged for the rest of the year. Subsequent messaging has been more hawkish despite a few notable dovish nods. With the next jobs and CPI reports landing after the decision — hawks have an excuse to plead for “patience” and a meeting-by-meeting approach.

However, it’s the voters who matter most and Chair Jerome Powell probably has a narrow quorum for a cut, but not a strong consensus to say that more easing next year is the base case.

A hawkish cut is one that stresses that the inflation gap matters more than the unemployment gap based on financial conditions being “loose” because equities are high and credit spreads are tight.

It would stress that neutral is above 3%, that policy is only “modestly” restrictive and that future moves depend on “incoming data” rather than the clear deterioration already visible in labor market readings and credit access.

Markets would read that as one-and-done or, at best, a much shallower future path of easing until new leadership/personnel is established.

Front-end yields would stay elevated in real terms, the dollar would rally and the risk premium on equities and credit would need to rise to compensate for the Fed being behind the curve on labor markets.