Top of the Morning: State of the U.S. economy & Fed monetary policy
The desk positions that the protracted U.S. government shutdown will critically dampen economic momentum, contributing to the anticipated weakness in the labor market which circles back to Federal Reserve monetary policy adjustments. Per the full note , Paul Hsiao of UBS underscores an expected softening in job growth, supported by alternative indicators like the recent ADP employment report which shows signs of further economic sluggishness. As market participants anticipate this trend toward a dovish Fed, the lack of fresh economic data will likely keep volatility elevated in the FX space, particularly for dollar pairs as traders adjust expectations heading towards 2026.
What the desk is arguing
The current state of the U.S. economy is poised for more significant challenges, especially if the government shutdown persists, as articulated by Paul Hsiao. This scenario is leading the desk to expect that the Fed may pivot more decisively towards rate cuts, driven by labor market weakness and stunted economic indicators.
Supporting this thesis, recent revisions to job growth figures and disappointing ADP numbers have already confirmed a negative trend in employment data, which further strengthens the narrative of economic vulnerability as indicated by UBS. Consequently, the uncertainty regarding the government’s ability to report key economic data only adds to the climate of hesitation that traders are feeling.
Where it sits in our coverage
Currently, our consensus target for USD pairs is 1.075, encapsulated within a range from 1.04 to 1.12. Aligned firms include: - jpmorgan: targeting 1.10 for Mar26. - This view aligns closely with jpmorgan but sits at the upper end of the consensus spread, reflecting a more optimistic outlook compared to bofa, which is at 1.04 for Mar26, suggesting some divergence in sentiment among market participants.
How other firms see it
The general sentiment among firms like jpmorgan and others suggests a consensus towards a more dovish Fed policy influenced by labor market weaknesses. In contrast, bofa represents a more cautious approach, forecasting lower levels amid the ongoing uncertainty.
Watch the USD pairs closely against economic indicators such as the employment reports since they will likely drive market sentiment and positioning significantly, especially if jobs data remains subdued, echoing the Fed's cautious stance.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Prolonged U.S. government shutdown suppresses economic activity.
- 02Labor market indicators reveal weakness, pushing Fed towards potential rate cuts.
- 03Expect heightened volatility in FX markets as data becomes scarce.
- 04Market positioning will adjust as traders brace for near-term labor report impacts.
Market implications
Traders should watch for any movement towards the consensus target of 1.075 in USD pairs, as the ongoing government shutdown and weak employment data converge. The outlook remains sensitive to labor market updates, especially as the delayed jobs report could sway market sentiment considerably.
Risks to this view
A reversal in this outlook could occur if the government resumes operations and a strong employment report emerges, contradicting the current narrative of labor market weakness. Additionally, any unexpected hawkish signals from the Fed could cause significant volatility regarding USD pairs.
Hi, everyone. Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel.
For today, we will take a health check on the state of the U.S. economy, cover the road ahead for monetary policy, and speak about the overall impacts and implications of a U.S. government shutdown to economic activity. Joining me here for the conversation from the UBS Chief Investment Office, glad to welcome back Asset Allocation Strategist for the Americas, Paul Hsiao. With that, Paul, thank you for dropping by, for spending some time with our listeners, our clients.
Nice to have you back with us. My pleasure, Dan. Thank you for having me.
So, Paul, heading into the week, the intent was to cover the September jobs report on this morning's episode. However, with the U.S. government shutdown having taken effect midweek this week, there is currently a pause with respect to the release of government economic reporting. Though I am curious, do you have a sense for what the health of the labor market looks like with the data we do have?
And with respect to a prolonged government shutdown, what are some potential impacts, implications to economic activity? Yeah, thanks, Dan. I think when it comes to assessing the labor market data, the general story is that forecasters, market participants are expecting just general softness in the labor market, and that's been one of the large reasons why we believe the Fed's been more proactive in rate cutting, especially this year.
Job growth has been weakening for some time. We had that revision earlier this year that really put into question the trend of job growth, and without the official nonfarm payrolls report, a lot of market participants have to look at alternative indicators like the ADP employment number, where we had a pretty weak number that just came out, and the revisions also showed generalized weakness. So that's a private sector report that already confirms weakness, and we had the earlier numbers from nonfarm payrolls showing pretty prolonged softness in the official numbers, so that's what market participants were expecting going into this report this year.
In terms of a government shutdown, usually markets tend to look through that when it comes to the stock market and bond market, but real economic indicators like consumer confidence, spending to some extent, can be weakened around this time because you have hundreds of thousands of government workers who are either furloughed or they're having their next paycheck put into question. So the longer a government shutdown gets put into place, the more pronounced this weakness becomes. So outside of the labor market, which of course is a very significant component of economic activity, how would CIO currently assess the health of the overall U.S. economy?
Right. So while we have weak softness in the labor market, and part of that is it comes from both sides, you have definitely a relaxation for demand of labor, but also in supply with the ongoing immigration controls, and just fewer people quitting their jobs right now amid some economic uncertainty. So even though you have softness in the labor market, and they said that that's been what's been driving a lot of the Fed policy right now, consumption, which makes up three quarters of the U.S. economy, has been actually holding up quite well.
We have the recent retail sales numbers that seem unfazed by higher prices and tariffs, and we have the Atlanta Fed GDP now number tracking a near 4% quarter-to-quarter annualized rate for Q3. So that would be two quarters of above-trend growth, which is something that a lot of forecasters didn't expect in a year where we have a lot of economic uncertainty and also the negative effects from the tariffs. So the U.S. economy, it's running on—I think it can be confusing to read because usually when you have job growth slow down a lot, this usually leads to layoffs and then unemployment rising.
We don't have that so far. Layoffs have been still quite low. Consumption has been quite strong.
Part of that is due to just wage growth running above inflation, so your real wage gains, but also consumption has increasingly become unequal in that higher incomes, the top 10% of income are driving anywhere between 40% to 60% of income. So just the bulk of consumption right now and those households have been really buoyed by healthy balance sheets, thanks to stock market and housing market appreciation. So as long as that keeps continuing, it's hard to see consumption really slowing down meaningfully.
That certainly takes up our GDP expectations for this year, just mechanically looking at the revisions from Q2 and looking at a pretty decent number for Q3. So overall conditions are still quite good, just one particular softness in the labor market that I think market participants and the Fed is watching out for. And with the Fed, Paul, if we take a look at monetary policy coming off of the September FOMC meeting where we did see the central bank cut rates by 25 basis points, what are CIO's expectations for the road ahead as we make our way through the balance of 2025 and even into 2026?
We still expect the Fed to ease its policy slowing into this year, about two more cuts for this year and then one more cut in 2026. So that's about 100 basis points of rate cuts total. And that should take policy much closer to what we estimate to be, what some estimates to be the neutral rate or where policy is neither stimulative or restrictive at that point.
And I think that's somewhat in line with consensus. And I think the signaling from the Fed, especially from the conference that we got in September, is saying that the direction of travel is clearly for lower rates. But I think the Fed is at a difficult position because of this sort of contradictory data in the U.S. economy where we have definitely a weaker labor market but still buoyed by healthy consumption.
One of the Fed's mandates obviously is to keep maximum employment. That's part of the reason why they're easing rates right now. But if the economy still is quite good, even some upside, some risk to the upside in the second half of the year, and you have some inflationary effects due to tariffs, I think if the economy keeps running at a pretty healthy pace and prices rise a little faster than expected, that could inhibit further rate cuts from the Fed.
That's something that markets are watching out for. I wanted to point out something else with the Fed, which is just due to personnel. I think September was the first time we had a Trump 2.0 appointment in Steve Mirren go to the board.
For markets, what this means is more of a dovish tilt going into 2026 expected from the Fed. That's led to, I think, anticipated steepening in the two-tenths curve, for example, in the fixed income market to anticipate, I guess, this dovish tilt from the Fed. On the point of personnel within the Fed, Paul, just given the headline we did see this week, that Supreme Court ruling, does it appear that Fed Governor Cook's post will remain intact as of now?
It seems to be the case. I think the issue is that a lot of policy right now from the White House doesn't have a lot of precedent. With so many things going on, for us, it seems that there's a lot of avenues to track whether it becomes uncertainty from tariffs, uncertainty from legislation and shutdowns, and then uncertainty from personnel.
This is just one more thing to add. The time being, it does look like Lisa Cook will serve at least through January, if not anymore. But regardless, I think whether Lisa Cook stays on or not.
In my case, most folks think that Lisa Cook is a dove. I think this actually helps the White House when it comes to their desire to lower interest rates. Got it.
Well, thank you, Paul, for the clarity on that and for spending some time with our listeners, our clients on this Friday morning to provide a state of the U.S. economy and share some thoughts on the road ahead for monetary policy. Very productive conversation. So thank you again, Paul, and do look forward to having you back on the program again soon.
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