The latest US employment data cool market expectations of a sharp interest rate cut
October 15, 2024
Topic of the week:
As expected, the Fed decided to lower interest rates by 50 basis points (to the 4.75%-5.00% range) at its September meeting, thus initiating a new phase of monetary policy tightening as inflation levels have consistently moved closer to the 2% target. The decision was virtually unanimous, and the dot plot published shortly afterwards indicated that it could be lowered by another 100 bps by the end of the year and by a further 100 bps over the course of 2025. In his subsequent speech, Powell stated that they still see the US economy as strong, and therefore the Fed’s objective with this move is to encourage both growth and employment to continue on the same path. In fact, he warned of the possibility that the neutral rate where the Fed stops lowering rates could be significantly higher than what was considered normal in pre-pandemic times.
The reality is that the data being released in the US in recent weeks has been mixed. The manufacturing PMI for instance remained unchanged at 47.2, still in contraction territory, while the services PMI rebounded from 51.5 to 54.9, above expansion levels. Also on the positive side, a good second quarter GDP figure was published, with growth of 3% (compared to 1.6% in the previous quarter), which undoubtedly reaffirms Powell’s discourse that the US economy continues to move at a good pace. The big surprise came in the employment data, where the growth of non-farm payrolls beat all expectations, as where an increase of 147,000 was expected, it finally grew by 254,000. The trend in employment growth has been stable all year, as evidenced by both the employment rate (which has already recovered to pre-pandemic levels) and the average monthly employment growth in 2024 (measured by non-farm payrolls), which stands at 204,000, already above the pre-pandemic (2011-2019) average of 194,000. Additionally, the unemployment rate fell again from 4.2% to 4.1%, ending definitively the upturns we had seen earlier in the summer, with a slight increase in wages.
As for inflation, both the Personal Consumption Expenditure (PCE), where the overall index fell from 2.5% to 2.2%, while the core index remained stable at 2.7%, and the CPI, which fell one tenth of a point at the overall level and rose one tenth at the core level, maintained their downward trend and are close to the 2% target set by the Fed.
With all this, the market has repositioned itself in terms of expectations of rate cuts, and the yields of the main benchmark bonds, starting with the US, have risen sharply in the last few sessions. Fed Chairman Powell himself, in recent statements, confirmed that if the economy continues on the expected path, we are likely to see two 25 bps rate cuts between now and the end of the year, when, as we have mentioned, the market was discounting 100 bps.
In Europe, for its part, the European Central Bank once again lowered rates by 0.25% (the decision was unanimous and expected), leaving the deposit rate at 3.50%. Lagarde’s speech was quite different from Powell’s, and the fact is that in Europe there is no longer concern about inflation but about the economic progress of the eurozone, with a special focus on the situation in Germany and France. In fact, at least two further 25 bp cuts are anticipated, one of them probably in October. Lagarde made it clear that they did not need to wait for inflation to reach 2% before lowering rates again, as the poor macroeconomic data in general in Europe is very worrying. The latest industrial PMI data came in well below expectations, with Germany in particular posting a very weak 40 points, far below the 50 level that indicates expansion. Only the services indicator held up, slightly above 50, but far from the previous 52.9. France, on the other hand, also published a very weak PMI (44.6), and is additionally going through major budgetary problems, with a public deficit that could exceed 6%, which is why the new coalition government is considering different measures to significantly increase revenue.
As Lagarde said, inflation no longer seems to be the main problem in Europe. The latest price data for September, which was slightly down at the core level from 2.8% to 2.7% (previously 2.9%), and posted an even more significant decline at the headline level, from 2.2% to 1.8% (previously 2.6%), already below the European Central Bank’s target.
In Asia, at the end of September the People’s Bank of China (PBOC) approved a new stimulus programme to try to reach the growth targets set in its strategic plan (5% per year). In addition to reducing the reserve ratio required of banks by 50 bps and lowering interest rates by 20 bps (to 1.5%), liquidity was injected into the system to encourage financing for share purchases and measures were implemented to support the purchase of vacant homes by local governments, thus reducing the stock of empty housing. Although the reaction of the markets has been extraordinarily positive, with rises of more than 20% in just a few sessions, the question arises as to whether this new programme will be enough to change consumption and investment habits in China, especially now that speculation is beginning to mount about a possible balance sheet crisis like that suffered by Japan a few years ago (price bubble in real estate assets, high indebtedness with real estate as collateral, bursting of the real estate bubble and, therefore, the over-indebted investor begins to be a net saver, which could lead to a deflationary period). We shall see whether the Chinese stock market’s meteoric rise is consolidated in the coming days, but at the very least, this has been a first step towards the economic reaction of the Asian giant, which as we know has a very important weight in the global economy.
The beacon of the markets:
The start of the fourth quarter has maintained the positive tone seen throughout the year in equity markets. In the US, the S&P 500 set a new all-time high at 5,822 points, and on Friday closed very close to that level with a weekly gain of 1.11%, while the Nasdaq 100 was up 1.18%, consolidating the 20,000-point benchmark. In Europe, the Euro Stoxx 50 ended with gains of 1%, the Ibex being one of the laggards with a gain of only +0.52%.
In the fixed income markets, the great employment data in the US continues to weigh, which together with somewhat higher than expected inflation, is causing an adjustment of some magnitude in the estimates of when and how much the FED will move. Thus, the 10-year Treasury yield rose to close at +4.07%, 9 bps higher than the previous week. In Europe the increases were more moderate, +6 bps for the Bund and +4 bps for the Spanish Bono, which closed the week at +2.27% and +3.01% respectively.
Among alternative assets, gold rose again for another week, albeit moderately, by +0.32% to USD 2,667.80/oz, thanks to Friday’s strong rebound and with the market concerned about the developments in the Middle East. The same reason was behind Brent’s rises, up 1.02% in a particularly volatile week as it traded in a wide range from 75 USD/b to 81 USD/b. The week started with some corrections due to the lack of strong measures from the Chinese government, which were expected to be announced at the weekend.
On the macroeconomic front, the most important data came from the US, where the CPI was one tenth below the previous month but also one tenth above what the market expected, closing September at 2.4%. At the underlying level, the same effect occurred, which meant an increase to 3.3%. On the other hand, at the employment level, there was an increase in benefit claims, but this figure should be taken with caution as it could be affected by the hurricane season that is coming to the US coasts. Lastly, the Atlanta Fed’s GDP forecast for the third quarter was raised to +3.2%.
This week we will see GDP data for the third quarter, import and export figures as well as CPI in China. In Europe we will see the industrial production data, the CPI data for September for which no changes are expected, and also the ECB meeting, to which the market gives a 95% probability that it will lower interest rates again by 25 basis points. In the US, there will be no major macroeconomic releases, with employment and retail sales being the highlights of the week.
Friday kicked off the earnings season in the US where the data releases triggered notable gains among US banks. Wells Fargo gained +5.61% at the close compared to +4.44% for JP Morgan or +3.63% for Blackrock. The numbers were not spectacular, for example, JP Morgan’s profit in the last 12 months fell by 1.9%, but this was much better than the market was expecting. We will see if the good tone is maintained in the coming weeks, which is what the market is waiting for in order to continue with the buy orders.
The quote:
And we leave with the following quote from Julia Ward Howe, American writer, activist and social reformer, women’s rights advocate and active anti-slavery campaigner: ‘It is always legitimate to wish to rise above oneself, never above others’.
Summary of the performance of major financial assets (10/15/2024)
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