Could "diverging" U.S. consumer spending and employment growth impact Fed policy?

Investing.com - The Federal Reserve is widely tipped to cut interest rates at its upcoming policy gathering next week, although a follow-up reduction in December will depend on how a "divergence" between strong consumer spending and weak employment growth is resolved, according to analysts at BCA Research.

Last month, the Fed slashed borrowing costs by 25-basis points to a range of 4% to 4.25%, citing a need to prioritize supporting an easing U.S. labor market over signs of sticky inflation. In theory, lowering rates can spur investment and hiring, albeit at the risk of driving up price gains.

Several members of the rate-setting Federal Open Market Committee, including Chair Jerome Powell, have since broadly indicated that they will continue to focus on bolstering the employment picture -- although without several fresh economic data pieces due to an ongoing federal government shutdown, the economic outlook remains somewhat murky.

Markets are now all but certain that a further reduction will be rolled out at the conclusion of the central bank’s October 28-29 gathering, according to CME’s closely-monitored FedWatch Tool. Another quarter-point drawdown is also seen coming at the Fed’s following meeting in December.

But, in a note, the BCA analysts including Ryan Swift and Robert Timper flagged recent comments from Fed Governor Christopher Waller which they suggested were indications that a December drawdown is "not assured."

They particularly highlighted Waller’s focus on evidence which has hinted at resilient U.S. consumer spending activity even as employment growth wanes. Waller, a more dovish voice at the Fed, said earlier this month that "[s]omething’s gotta give -- either economic growth softens to match a soft labor market, or the labor market rebounds to match stronger economic growth."

The analysts added that explanations of a so-called "K-shaped" recovery, in which different sections of the economy rebound at different magnitudes or times, do not "adequately explain the divergence."

"At some point either employment growth will rise, or consumer spending growth will fall. Our bet is on the latter," they wrote.

Still, the analysts warned, while weak employment growth will ultimately drag spending lower, "this may not be evident in the data before the end of the year."

Against this backdrop, they backed "a tactical trade short the January 2026 Fed Funds Futures contract and long the December 2026 contract."