Payden & Rygel: US CPI
With inflation cooling and job growth slowing, the fed funds rate is still in restrictive territory. Does that make sense? Despite all the fiscal chatter, this is a great set-up for bonds in the second half of 2025.
Core CPI recorded its fourth consecutive soft reading in May after a hot start to the year in January. The inflationistas will say “just wait until next month for the tariff effects to hit the data,” but even if goods prices perk up in the summer reports, softness in the services components in May (housing and non-housing services), suggests the disinflation trend could be more persistent.
Meanwhile, job growth is slowing but not collapsing, with the 3-month moving average ticking down to +137k in May. It was just enough to keep the unemployment rate at 4.2%. We expect job growth to keep slowing in the second half, nudging up the unemployment rate. Also keep in mind the Fed remains “on hold” in restrictive territory at 4.25-4.50%.
As a result, we still see two avenues to rate cuts in the second half. First, inflation could continue to cool as the tariff effects fade. Tariff-price scare gone and inflation expectations in check, the Fed could resume cutting. Second, the risk to the unemployment rate is to the upside. Continuing claims for unemployment hit a fresh cycle high in recent weeks, pointing to a higher unemployment rate from here.
We suspect the unemployment rate jumping to 4.4% or higher will re-focus the Fed’s attention on what matters most: the downside risks to growth. Regarding the next Fed chair sweepstakes, we find ourselves firmly in the pro-Waller camp. No need for Trump to implant a new policymaker, Waller fits the more dovish bill.
Finally, while we’re not fans of the “big, beautiful budget bill” worming its way through Washington, we don’t think the U.S. is going broke anytime soon. Since bond bears have built plenty of term premium into the longer end of the Treasury curve, we think the fiscal story is old news at this point.
We’re biased, of course, as a bond shop, but interest rates might move lower over the second half of the year as fiscal, inflation, and tariff fears move into the rear-view.