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Video:Deep Dive – A pivotal moment for fixed income (7 min)
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Top central bankers will arrive in the US state of Wyoming today for the Federal Reserve’s annual Economic Policy Symposium, which will take place over the next three days. Markets will be squarely focused on Federal Reserve Chair Jerome Powell’s keynote on Friday, his eighth and final Jackson Hole speech, as investors look for signals about the US central bank’s next policy move in September.

Fed chairs have used the symposium in the past to announce changes to the monetary policy outlook. This time last year, Powell said the “time has come for policy to adjust,” opening the door to the start of the current easing cycle.

Investors may now hope Powell will give a similarly definite cue, with fed funds futures indicating an over 80% chance of a Fed cut next month. In recent statements, Powell has made the case that there is still a risk that the rise in US tariffs could lead to a sustained acceleration of inflation. Minutes from the last Federal Open Market Committee meeting in July also showed that the majority of policymakers viewed upside risks to inflation as the greater concern.

But Powell’s public comments and the Fed’s last policy meeting came before the release of the weak July labor report, which showed job growth on a clearly downward trend. Our view is that recent data has strengthened the case for imminent easing from the Fed, and we expect the federal funds rate to be 100 basis points lower over the next six months.

A weakening labor market should justify a fresh round of policy easing. Titled “Labor Markets in Transition: Demographics, Productivity, and Macroeconomic Policy,” the theme for Jackson Hole this year suggests that labor market conditions will be key in the Fed’s next move. Powell has stated that the unemployment rate is the best measure of the labor market, but that does not mean the current relatively low unemployment rate would automatically keep officials on hold. History shows that when unemployment starts to rise, it can move quickly, and the Fed kicked off the easing cycle last year on concerns that the labor market could deteriorate faster than anticipated. The latest Fed minutes also indicated that officials expect the labor market to weaken, with the unemployment rate projected to move above policymakers’ estimate of the natural rate toward the end of this year and to remain above that level through 2027. With recent data pointing to softening labor demand, we think the downside risks in the labor market are likely to outweigh inflation concerns.

Inflation is likely to rise at a modest pace, in our view. Tariffs are starting to feed through to higher price pressures in the US, with underlying consumer inflation in July increasing at the fastest pace since the start of the year, and wholesale prices posting the largest monthly increase in three years. We expect overall inflation to continue on a gradual upward trend as businesses pass along their higher costs, but we believe slowing shelter inflation and pushback from increasingly stretched consumers should help offset some of the tariff impact on inflation. A slowing economy should also help blunt some of the inflationary pressure driven by tariff hikes.

Slowing economic growth would also call for the Fed’s support. The US economy expanded by 1.2% in the first half of this year, well below its 2% trend rate and the 2.8% growth in 2024. With economic activity likely to stay soft in the second half of the year, we believe growth risks will increasingly be an important consideration for the Fed. According to the minutes, several officials stated that they expected growth in economic activity to remain low in the coming months, and that slower real income growth may be weighing on consumer spending. We estimate that tariffs will ultimately reduce US GDP growth by around 1 percentage point.

So, with the Fed looking set to resume rate cuts shortly, we think the time to put cash to work is now. High grade and investment grade fixed income offers attractive risk-reward, in our view, and we favor medium-duration bonds of around 5-7 years.