It’s Still a Reach for a Goldilocks Outcome… (Podcast Edition)
The desk maintains a cautious outlook on the potential for a Goldilocks scenario in the current macroeconomic landscape, emphasizing the Fed's likely pivot amid a weak labor market. Per the full note from MUFG EMEA, George Goncalves highlights that ongoing revisions in labor data could prompt a shift in the Fed's stance, potentially leading to easing measures. This perspective aligns with our view that the U.S. economy is at a critical juncture, with implications for FX markets, particularly in light of the recent government shutdown. The desk's analysis suggests that the interplay between labor market dynamics and central bank policy will be pivotal in shaping currency movements in the near term.
What the desk is arguing
MUFG is maintaining its long-held view that a weak labor market and large revisions in economic data will compel the Federal Reserve to pivot towards easing by September. However, the evolving economic landscape, particularly in light of the first official day of the government shutdown, introduces uncertainty regarding the timeframe and extent of such moves.
Support for this outlook comes from extensive analysis of Asia's FX reserves, showing a shift from dollar accumulation that could dampen U.S. Treasury demand. The implications of tariffs and changing trade dynamics may be less conducive to recycling dollars, raising questions about future capital flows and their impact on the U.S. economy.
While MUFG's perspective emphasizes the potential for easing, they implicitly reject the counterfactual that a stable or recovering labor market could lead the Fed to maintain its current rate policy in the near term. The ongoing government shutdown further complicates this picture, presenting scenarios that could shift the economic landscape significantly.
Where it sits in our coverage
Our consensus target does not specifically incorporate a currency but aligns closely with MUFG's outlook on potential Fed easing and its impact on interest rates. Currently, we maintain a firm spread of 1.075, reflecting a careful watch on economic indicators and external variables such as the government shutdown, which may influence broader market sentiments.
Market views vary, with notable targets from major banks suggesting varied perspectives. For example:
Barclays and Goldman Sachs appear to align closely with MUFG's cautious stance on Fed policy, reflecting the potential for market shifts should labor market conditions worsen or remain stagnant.
Conversely, BofA diverges from this perspective, forecasting a more conservative approach from the Fed, suggesting a target of 1.04, indicating a belief that inflation may necessitate continued tightening rather than easing.
01MUFG maintains a cautious outlook amid weak labor market indicators and a potential Fed pivot towards easing.
02Ongoing government shutdown presents uncertainty, impacting economic scenarios and market sentiments.
03Changing dynamics in Asia's FX reserves could influence future U.S. Treasury demand.
Market implications
The evolving narrative around the Fed's policy could have significant ramifications for USD liquidity and other asset classes, necessitating careful monitoring of labor market developments and fiscal policy impacts amid ongoing geopolitical tensions.
Risks to this view
Key risks include an unexpected economic rebound that could delay Fed easing, potential geopolitical events influencing market stability, and further deterioration in labor market data that may exacerbate recession fears.
Welcome to the MUFG Global Markets Podcast. I'm John Cook and I'm joined today by George Goncalves, MUFG's Head of U.S. Macro Strategy.
It's Wednesday, October 1st, 2025. Welcome back to the podcast, George. John, it's been a long time.
I've lost track. I'm not even sure if we even recorded something in September. It's been one of those busy months.
Yeah, I could be wrong, but I think our last episode might have been back in July, so we've been remiss. August. Maybe August.
Was it August? Okay. It was August, but not without good reason.
We were all over the place. We and you, especially, were all over the place seeing clients. We held a series of very well-received seminars in Boston, Boston, and Toronto where we explored the intersection of U.S. and Japanese markets.
We had some special guests from Tokyo, as you know. You were just in non-Japan Asia for over a week, if I'm not mistaken, so I'm thinking that you'll have some good content from those conversations with clients. At the same time, you just published your Macro to Markets Monthly, so why don't we start there?
A couple of the sections in the monthly talk about your assessment on the economy, on the labor market, as well as on the FOMC. We all know that the Fed has pivoted and restarted the easing cycle. Given where we are now versus where we were maybe before Jackson Hole, what's your thinking in terms of what the market's price for the Fed going forward?
I think it's also maybe a good opportunity to work our way backwards because in this last six weeks, things have really changed dramatically. As you described, the Fed has pivoted. We've now started the easing cycle, but in many ways, it's lined up with our house view.
Maybe one or two meetings later than what we thought. We've been really critical, thinking that the Fed should have started sooner, that they've been behind the curve, that had they known the revisions, both in terms of the monthly revisions for the NFP, as well as the large benchmark QCEW revisions that we got at the beginning of September. If they had all that information at the beginning of summer, they'd be cutting already.
We feel pretty good about the Fed pivoting. They've started with a very cautious stance by only starting up again with 25 versus last year where they started with 50. I think those are all the right ways of doing it.
There's a lot of uncertainty still on inflation. They've been over four years above their target, and they're once again starting to cut rates. It's definitely putting them in a really awkward, tough position with the labor market clearly not as strong as they thought it was and inflation still staying sticky.
Our view, I think, has largely come to fruition. We think that there's a number of cuts still ahead for 2025. Our convictions start to fade out the further out we go.
That's where I think it gets interesting because markets have almost a linear pricing going on with a total of over 100 basis points of cuts, which we generally agree is the right sort of prescription. It's just a matter of how it gets executed. There's also the questions around Fed independence.
There's questions around who's going to be the next Fed chair, are they going to pass the baton with these levels of rates or lower? This year, we're confident with two more cuts at the last two meetings, October and December, bringing 25 to three cuts, which has basically been our house view, plus or minus 25 basis points for the last year. Yes, it's kind of interesting.
You've been ahead of the curve in terms of the market not pricing enough, and now it seems like you're – I don't want to say behind the curve here, but it seems like with the market pricing so many cuts, you're maybe a little – at the very least, a little less bullish. What do you think? Just as kind of a follow-up there, help me understand what you're thinking about cuts for next year.
To some extent, the Fed should be leaning more dovish. You're going to have a new Fed chair appointed by Trump who presumably will at least share his view that rates should be lower right now, so the makeup's a bit more dovish. Given what the market's pricing, what do you think can the Fed will do in 2026?
Yes, and that's definitely a point for those that are receiving our strategy reports. Figure five in our piece really kind of lays out a couple of different potential paths where although our house view is that we think they'll cut two more times this year, next year cut at every other meeting, but that's really just to kind of give us flexibility, to be honest, around the idea that we think neutral is close to three, so if they cut three times next year and they kind of slow walk into it, that's largely kind of what the linear pricing is showing as well in the SOFR curve, the Fed Funds Strip. But there's obviously other potential avenues of how things may go.
We might see the Fed cut two times and then at the start of next year go on a longer pause, I'm sorry, skip January and then come March maybe inflation data is starting to hit higher because of the tariffs or the economy's doing better and activity improves. Right, yeah, I've heard you say that some of the pro-growth parts of the big beautiful bill, as example, might start to kick in and that could help the economy bounce, right? Exactly, and then also tax returns in April, if small businesses take advantage of the accelerated depreciation and we see an uptick in activity in Q4, they can get tax cuts and benefits in Q2, so yeah, there's definitely some potential tailwinds that could put the Fed back on the sidelines because we're not going to further ease into an accelerating economy, which then brings a potential risk of how that's going to be perceived by the Trump administration.
It's also during the transition period to the next chair, whoever that might be, so that could be like an extended pause of like six months until the next new Fed chair takes over. And that environment, yeah, that's not priced in, like markets pricing in very linear thinking towards a new scroll. Yeah, yeah, said another way, it was kind of easy to buy two-year notes when they're close to 4%, a little bit less easy to buy them when they're yielding 3.5%, a lot of it's in the price already.
In the interest of time, I want to get to some other sections of your piece, particularly the section where you discuss Asian FX reserves. This is like, I was like, oh, that's kind of an interesting section and then I was like, okay, George has spent a week and a half in non-Japan Asia. You probably have some unique and fresh insight from that trip.
Yeah, exactly. And a lot of this work actually was anticipating and actually some of the content we pulled together before my trip to try to at least explore and stress test some of these ideas with the clients in Southeast Asia, really kind of thinking through the last 20, 30 years, there was a large increase in reserves, reserves largely dollars. They've since kind of like the last five, 10 years really slowed down that reserve growth, like what's going on, how does that change?
And also kind of thinking through how are they thinking about recycling of dollars with tariffs? So, I thought it was appropriate to think through that from a low reserve connection back to Asia. And yeah, so we covered a lot of different grounds and we're left with a lot more questions than answers.
We do think that it's hard to replace the dollar ultimately, but there's new things that are being developed, like a lot of questions around stable coins and what that might look like and what does that mean for just general overseas overnight dollar activity and how that would work if the tariffs end up with less dollars actually and some substitution of foreign goods for U.S. goods, that means less dollars leaving the U.S., like who's going to be the marginal buyer of treasuries and just in general, how are they thinking about the yield curve? So, yeah, I think it's a fascinating time and it also lines up with our thesis that we've come full circle that the reason why reserve accumulation initially started was in reaction to the 1997, 1998 Asia financial crisis where a lot of countries were short funded or underexposed to dollars and then having dollar liabilities, not being unable to actually defend their currencies. So, they built up these large treasurer stock of treasuries and it's an interesting piece.
We went through some interesting analysis through FX interventions and how that also added to their dollar holdings and now with the world changing, will there be less need for that and will Asia currency strengthen and then less need to buy dollar products? Yeah, for sure. Very timely.
Like you said, more questions than answered, but that is kind of the big picture question for the treasury market, so definitely worth a read to our listeners. To wrap things up here, George, we would be remiss without discussing the government shutdown. So, again, we're recording this podcast on Wednesday, October 1st.
The government officially shut down at midnight. I've seen plenty of analysis on kind of previous government shutdowns, how they affect markets. We've talked about it a little bit on the desk.
This one feels a little bit different, but tell our listeners more. Sure. I do think this one is a little bit different and I think we have to kind of look at it from a few different lenses.
One, when is the shutdown taking place? This is at the start of a new fiscal year. It's October 1st.
The U.S. government operates on a fiscal calendar starting on October 1st. So, it's a new year for the U.S. government's budget and now they don't have one, so they're waiting on that. It's also the government, if they're abiding by the Byrd rule and only able to use the budget reconciliation process once per fiscal year, earlier this year, that's how the big, beautiful bill was able to pass without a majority of 60 votes.
They were able to pass with a simple majority of 51 votes because they were using the budget reconciliation process. They could do that once a year. So, technically, today would be the start of a new fiscal year.
They could do that if they want to, but then they end up using that option very early in the year. And so, the Republican having a majority in the House and Senate put forth a kind of continuing resolution to get the government funded into November, and that didn't pass because the Democrats are looking for some concessions on some of their focus points around the Affordable Care Act and things like that. And so, we're at this kind of loggerhead into the end of the week, assuming that this lingers, which we think it will, if we don't get a deal done before Friday probably goes into the weekend.
And I think that, you know, obviously has implications for what it means for the disruptive nature to both those that are being impacted because they're not working, and I think we've seen estimates from the CBO of like 750,000 federal employees will be offline per day, and that's a few hundred million in terms of actual lost income until they get paid back eventually. This one is a little bit different because President Trump has been suggesting that some jobs might get actually permanently reduced, and that's never really been how these government shutdowns were handled. So, we don't know if those are just leveraged bargaining chips or if he's really going to go through with that.
And so, that could have implications on actual federal job employment, which would then reduce, you know, overall labor data going into the end of the year months. And then if this were to really linger into the survey week of when the various, you know, data collection agencies are estimating the NFP number, that also cannot kind of impact things. And of course, the fact that the government's closed, the actual data releases themselves are not taking place, so that, you know, the markets are kind of flying a little bit blind without actual guidance of the jobs data, which we would have gotten the NFP on Friday.
But yeah, it's a lot going on. I do think the reason why this time is different, because this is like the one kind of point in time where, you know, the Democrats could at least apply some leverage back against the administration slash Congress and the House, that's majority Republican, to win some concessions on their needs. And so, I don't see how this gets resolved that quickly.
And so, we think as of, you know, as of time of recording and what we know as of now, it probably goes into the weekend. Right. And I think, you know, that's where, you know, going over the weekend, that's where you think the markets could react negatively, correct?
You know, whether it's risk assets, you know, selling off or perhaps treasuries catching a flight to quality bid. Yeah, exactly. So, I feel like the times of the essence, like, and the timing of the year, it's been an amazing year.
Stocks have really bounced back from Liberation Day. It would be kind of ironic that they start giving back some of the gains because of another kind of government policy snafu. You know, it would be ironic that this takes place at the end of the year.
But, you know, investors might just decide that, you know, it's enough uncertainty, take some chips off the table and just, you see some sort of a reduction in risk appetite until this is resolved. And so, yeah, I think that's, this could be the catalyst that people were just waiting for to kind of just take a reset moment. Yep.
Yeah. We were talking about this earlier, you know, stocks had a spectacular September when many, you know, many thought they wouldn't and seasonally they weren't supposed to. Yeah.
So, certainly, certainly at the very least, you're going into this pretty fully priced, you know, which has to, you know, has to, you know, be to some downside risk. So, I think we, so George, that was great stuff. I think we covered a ton of ground, you know, but there's a lot more in your Macro to Markets Outlook.
I would really encourage our listeners to check it out. It's entitled, It's Still a Reach for a Goldilocks Outcome. And again, if you are still not receiving George's strategy reports, do check out the MEFG Research Portal at www.mefgresearch.com where you can find all of your favorite MEFG research as well as assign it to have it conveniently delivered directly to your inbox.
Great stuff as always, George. Thanks very much. Thanks, John.
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