Keep a close eye on Friday's non-farm payrolls, the key factor for the Federal Reserve's rate cut in January: unemployment rate rises to 4.7%

The non-farm payroll report to be released this Friday has become a key variable in determining the Federal Reserve's short-term policy path. According to the latest report released on Monday by the Citigroup research team led by Andrew Hollenhorst, if the U.S. unemployment rate rises to 4.7% as expected in December, the Federal Reserve is very likely to continue to lower the policy interest rate by 25 basis points this month.

Although Federal Reserve officials have recently signaled that they are "not in a hurry" to further cut interest rates, the ongoing weakness in the labor market is changing this expectation. Citigroup believes that following the weak data in November, further loosening in the labor market will force decision-makers to reassess their stance. If the unemployment rate continues to rise, cutting interest rates to support the economy will become an inevitable choice.

The market is currently pricing in only 60 basis points of rate cuts for the entire year of 2026, which may underestimate the potential for policy easing. Analysts believe that with the balance of risks from a weakening labor market and cooling inflation, the baseline forecast for actual rate cuts this year is 75 basis points, and the possibility of exceeding 100 basis points cannot be ruled out.

As the data approaches on Friday, investors need to closely monitor specific signs of cooling in the labor market, which will directly determine whether the Federal Reserve will continue its rate-cutting pace since 2024.

Signals of Labor Market Loosening

Analysts noted in the report that the upcoming December employment report follows the November data, which showed continued loosening in the labor market. Citigroup's baseline scenario assumes that the unemployment rate will rise to 4.7%, continuing the previous upward trend, which will be a key variable in maintaining the Federal Reserve's rate-cutting path.

In terms of new job growth, Citigroup expects an increase of 75,000 jobs. Analysts specifically mentioned that Federal Reserve Chairman Jerome Powell previously explained that considering the downward revision of 60,000 jobs, this level of growth actually means that job growth is close to stagnation. Additionally, the Indeed job posting index is generally on a downward trend, and while initial jobless claims have fluctuated, they remain low overall. These indicators collectively depict a cooling job market.

Policy Path and Rate Cut Expectations

Looking back at the policy path, the Federal Reserve is expected to cut rates by 100 basis points in 2024, then pause, and cut rates by 75 basis points in 2025. Currently, although officials have reiterated that there is no urgency for further rate cuts, Powell has characterized the current policy interest rate as being at the "upper limit of the neutral range," which suggests room for further reductions.

The report argues that based on the experience of the past two years, once the labor market shows clear further weakness, the Federal Reserve will resume rate cuts. Although the decision-making model of successive meetings makes the exact rate-cutting path highly dependent on data and difficult to predict, the overall trend points towards easing. Looking beyond the monthly data fluctuations, the unemployment rate has shown an upward trend over the past two years, combined with cooling inflation in the service sector (especially in housing), providing a macro foundation for rate cuts.

Macroeconomic Environment Supports Deeper Rate Cuts

In addition to employment data, other macro indicators also support a dovish stance. Oil prices have mainly remained below $65 per barrel, helping to alleviate inflationary pressures. Meanwhile, although the December ISM manufacturing index may show slight improvement, it is still expected to remain in the contraction zoneCitigroup analysts pointed out that the overall risk balance for 2026 leans towards a weak labor market and further decline in inflation. Compared to the market's pricing expectation of only a 50 basis point rate cut or less, the likelihood of the Federal Reserve ultimately implementing a rate cut of more than 60 basis points is much greater. If unemployment rate data validates the market's judgment of loosening, the yield curve may steepen further