BNY macro strategist John Velis maintains a forecast for three Federal Reserve rate cuts in the second half of the year despite geopolitical tensions and firmer producer prices. He argues that a weakening U.S. labor market will ultimately drive easier policy, potentially steepening the curve as front-end yields fall and long-end yields rise.

Labor concerns anchor dovish Fed outlook

"Against the backdrop of current geopolitical events, we don’t alter our view for three rate cuts in the second half of the year. The market’s rates curve hasn’t materially moved since the attacks began – with two cuts for the year, even with slightly higher (for the moment) oil prices and a small concomitant increase in inflation expectations on the day."

"Inflation last week, in the form of producer prices, was disappointingly high, driven largely by services – especially trade services, which is a proxy for margins. As firms pass on higher prices due to tariffs, their margins should rise, and this subcategory of the PPI increased by 4.2%."

"Our rate call, however, rests on our concern over the labor market, which we note is at best flat and could be in for another turn lower. Even in a sticky inflation world, we think that if the labor market deteriorates further, the FOMC will address that with looser policy at the expense of inflation."

"This could have the related effect of raising long-end yields, even as front-end yields would likely fall, resulting in a steeper curve."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)