Consecutive rate cuts may be ahead as economic pressures mount

Fed rate call change: now expecting back-to-back rate cuts in October and December, instead of December only. 

Financial markets are now pricing in two additional Fed rate cuts by year-end — a trajectory we view as optimal. Yet, heading into the government shutdown, our expectation was for a more measured recalibration from the Fed. At the time, we noted that an October cut remained possible, though it would likely require a materially weak September jobs report — potentially negative or near-zero. Our baseline stood at a moderate 80,000 gain, even as we anticipate negative October payrolls from weak private sector hiring and significant federal job losses tied to Department of Government Efficiency (DOGE) -led cuts. 

The government shutdown is compounding an already fragile backdrop, with each week of paralysis expected to shave roughly 0.1 percentage points off real GDP growth — on top of mounting operational disruptions and a growing erosion in business and consumer confidence. With official statistics sidelined, the Federal Reserve is being forced to lean more heavily on private sector indicators, which, so far, paint a troubling picture. The ADP® National Employment Report showed a loss of 32,000 jobs in September — the first decline since early 2022 — while both the ISM Manufacturing index and the ISM Services index reflected broad-based weakness in business activity, underscoring the economy’s lack of momentum heading into the fourth quarter.

As we’ve often emphasized, there has been a material disconnect between sentiment and economic activity post-pandemic. Still, the current slate of sentiment indicators offers little evidence of momentum heading into Q4. And in the absence of government data, private sector actors — from businesses to investors — are becoming more cautious in their decision-making. That increased uncertainty, in turn, is raising the risk of financial market volatility.

Purchasing managers across service industries are only beginning to report drag from newly imposed tariffs and renewed supply chain friction. Their top concern is rising costs — across food and feed, industrial materials, pharmaceuticals, capital equipment and retail goods. More broadly, outside of artificial intelligence (AI) -driven sectors and resilient high-income consumer segments, final demand appears muted and economic anxiety is growing.

The ISM business services activity subindex — a close proxy for output — fell over five points into contraction, marking its first negative print since May 2020. The employment sub-index has now contracted for four consecutive months.

This increasingly fragile backdrop, compounded by a data vacuum and policy uncertainty, is likely to tilt the balance for Fed policymakers toward more policy easing in 2025. With 10 Federal Open Market Committee (FOMC) members supporting two additional rate cuts in September and nine favoring just one, it appears increasingly likely that we will see a rate cut in October and December.