Fed balance sheet drawdown may go on if jobless rate does not move higher – Citi

Investing.com — The Federal Reserve may face more difficulty in characterizing further aggressive interest rate cuts as “normalization” in the coming months if the unemployment rate remains higher than anticipated, according to analysts at Citi.

In a note to clients, the analysts also argued that, in this scenario, the Fed may be “pushed” into ending an ongoing balance sheet reduction drive despite elevated reserves.

Following a jumbo 50-basis point interest rate cut by the Fed last month, Fed Chair Jerome Powell said the central bank is not considering halting balance sheet reductions, citing “still abundant” reserves that are expected to remain so for some time.

As a result, he said continuing so-called quantitative tightening, or the Fed’s process of drawing down the liquidity it added through bond purchases made during the COVID-19 pandemic, is necessary.

So far, quantitative tightening has brought down the Fed’s holdings from $9 trillion in 2022 to currently around $7.1 trillion.

The Citi analysts predicted that, as long as the unemployment rate stabilizes “no higher that 4.4% and job growth holds up,” the Fed will stick with the runoff until the end of the second quarter of 2025

Investors will have the chance to parse through a fresh jobs report on Friday, which could help clarify the path ahead for Fed policy. Several officials have cited a need to prop up the labor market during a time of waning inflation as a major factor behind last month’s super-sized rate cut.

Economists expect the US economy to add 144,000 jobs in September, up slightly from 142,000 in the prior month. The unemployment rate, meanwhile, is seen matching August’s level of 4.2%.

In August, payrolls rose from a heavily-downwardly revised reading of 89,000 and were below forecasts of 164,000, while the jobless rate ticked down from 4.3%.