Barclays: The US economy and markets are still awaiting direction, while Warsh's communication framework has yet to provide policy clues

Overview

This is a Barclays US macro outlook report focused on the communication direction of the Federal Reserve's new policy framework under Warsh's leadership, June employment data, labor-supply constraints, second-quarter GDP tracking, the impact of the Supreme Court's Cook case on Federal Reserve independence, and revisions to PCE inflation measurement. The report argues that the economy and markets still lack clear policy direction, and that current data provide only marginal support for the baseline case of an extended hold on interest rates.

Core views

The report's central views are: First, Warsh provided no clear clues about the policy reaction function at Sintra, but his opposition to forward guidance could lead the Federal Reserve to shift from providing interest-rate-path guidance toward explaining policy objectives, rationale, and risk assessments. Second, June employment data showed moderate cooling, with nonfarm payrolls increasing by 57k and the three-month average falling to 111k per month, but the labor-force participation rate declined significantly, particularly among those aged 25-34, indicating that supply constraints such as slower immigration continue to limit the pace of sustainable employment growth. Third, underlying US economic activity remains solid, with Barclays tracking second-quarter real GDP growth at 2.1% q/q saar. Fourth, revisions to PCE measurement could reduce some core inflation readings but would not fundamentally change the view that inflation remains above target.

Analysis framework

The report combines analysis of the Federal Reserve's communication framework, employment and household-survey data, JOLTS and wage-income indicators, GDP tracking models, interpretation of court rulings, and estimates of the effects of methodological revisions to PCE inflation measurement to assess the US monetary-policy path and macroeconomic risks.

Methodology notes

• Monetary policy analysisAssessment of the Federal Reserve's reaction function and communication framework

  Less emphasis on forward guidance

  Based on Warsh's speech at Sintra and indications that Mervyn King is participating in the communication task force, the report concludes that the new framework may place greater emphasis on explaining policy objectives and risks while reducing precise signals about the future interest-rate path.

• Macroeconomic data trackingGDP tracking model

  High-frequency data updates to second-quarter GDP tracking

  The report incorporates data on construction spending, auto sales, employment reports, and factory orders into its tracking model, with the current estimate for second-quarter US real GDP growth at 2.1% q/q saar.

• Inflation measurement analysisEstimate of the impact of annual PCE revisions

  Mechanical impact of methodological changes on core PCE

  The report assesses methodological adjustments by the BEA to categories including legal services, portfolio management services, computer software, and accessories. It concludes that these changes could lower core PCE momentum but would not alter the broader macro narrative that inflation remains above target.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• US Treasuries / US interest rates

  Directly affected by the Federal Reserve's policy path and inflation momentum

  Strengths

  Marginal cooling in employment data and PCE revisions could reduce near-term rate-hike pressure.

  Weaknesses

  Constrained labor supply and core inflation above target limit expectations for easing.

  Comparison

  Barclays' GDP tracking estimate is above those of Atlanta Fed GDPNow and S&P Global, indicating a stronger assessment of growth resilience.

  Risks

  If employment and consumption reaccelerate, yields could again price in rate-hike risks.

• US dollar

  Indirectly affected through interest-rate expectations, growth differentials, and policy uncertainty

  Strengths

  US growth remains solid, with second-quarter GDP tracking at 2.1% q/q saar.

  Weaknesses

  A less transparent policy communication framework could increase directional uncertainty.

  Comparison

  Compared with a narrative focused solely on cooling employment, the report places greater emphasis on the coexistence of growth resilience and inflationary pressure.

  Risks

  Changes in Federal Reserve communication, inflation revisions, and labor-supply data could cause volatility in US interest-rate expectations.

• AI-related macro themes

  AI investment supports manufacturing demand and also affects the measurement of certain PCE price categories

  Strengths

  The report argues that AI-related investment is supporting manufacturing demand, while Warsh also noted that AI productivity gains are beginning to emerge.

  Weaknesses

  Rising prices of AI-related hardware previously pushed up some core PCE components, and subsequent measurement revisions could change reported inflation.

  Comparison

  The report treats AI simultaneously as a growth support, a potential deflationary factor, and a source of inflation-measurement distortion.

  Risks

  If markets misinterpret measurement adjustments to AI-related price components, they could misjudge underlying inflationary pressure.

Key data

• June nonfarm payroll growth57kBelow Barclays' forecast of 100k and the market consensus of 113k, with the prior figure also revised down.
• Three-month average nonfarm payroll growth111k/monthBelow the 188k/month reported previously for May, indicating slower employment growth.
• June unemployment rate4.19%Slightly down from 4.30%, but the household survey showed declines in both employment and the labor force.
• Labor-force participation rate61.5%Down 0.6 percentage points since January, with approximately half of the decline occurring in June.
• Labor-force participation rate for ages 25-3482.4%Down 1.6 percentage points, representing a supply-constraint signal highlighted in the report.
• June average hourly earnings0.3% m/m; 3.5% y/yTogether with hours worked, this suggests approximately 0.4% month-over-month growth in wage income.
• Second-quarter real GDP tracking2.1% q/q saarAbove the Atlanta Fed GDPNow estimate of 1.2% and the S&P Global tracker estimate of 1.3%.
• Impact of PCE revisionsQ1 core PCE momentum could be revised down by 0.4-0.5 percentage points; May core PCE could be revised down by approximately 0.2 percentage pointsPrimarily related to measurement changes in AI-related price categories such as computer software and accessories.
• Supreme Court Cook case ruling5-4Allowed Lisa Cook to remain a Federal Reserve governor during the litigation, reducing uncertainty surrounding Federal Reserve independence.

Impact & implications

For asset pricing, the report conveys a message of "unclear direction, but a baseline still favoring a hold": softer employment data and PCE revisions reduce the probability of near-term rate hikes, but shrinking labor supply, resilient wage income, and inflation remaining above target mean that upside risks to rates have not been eliminated. If inflation, activity, and employment continue to slow moderately, market pricing for an extended pause in rate hikes will become more firmly established; if employment and consumption reaccelerate, the Federal Reserve may resume discussing rate hikes.

Risks

• Inflation, economic activity, and the labor market fail to continue cooling moderately over the summer, bringing rate hikes back into discussion.
• Employment and consumption reaccelerate while labor supply remains constrained by factors such as slower immigration, potentially causing the labor market to tighten more quickly.
• The June nonfarm survey response rate was only 54.4%, creating substantial risks of future revisions to employment data.
• PCE methodological revisions mechanically depress inflation readings; if markets misinterpret this as the inflation problem disappearing, they could underestimate policy risks.
• Although the Supreme Court's Cook case temporarily upheld Federal Reserve independence, subsequent political proceedings could still create uncertainty.

What to watch

• Whether inflation, activity, and labor-market data continue to cool moderately over the summer.
• The extent of subsequent revisions to the June nonfarm payroll report.
• The labor-force participation rate, particularly participation among those aged 25-34 and supply signals related to slower immigration.
• The actual impact of the September 30 national accounts annual revisions on core PCE inflation.
• Whether the Federal Reserve's framework review downplays the dot plot, policy statements, and forward guidance.
• Whether the July 7 international trade data explain the gold-related distortion underlying the divergence in GDP tracking estimates.