Fed Cut on Deck, Size in Question

For the week ending 13 September 2024

As of midday Friday, global equities were higher on the week, with US stocks up for four consecutive days. The yield on the US 10-year Treasury note declined to 3.66% from 3.68% last week while the price of a barrel of West Texas Intermediate crude oil fell to $68.72. Volatility, as measured by futures contracts on the Cboe Volatility Index (VIX), fell to 16.8 from 19.6 last week.

MACRO NEWS

Size of Fed cut remains open question

The US Federal Reserve has made it clear that the time for a policy rate cut has arrived. However, the magnitude of the cut remains an open question and is sure to be a topic of debate at next week’s FOMC meeting. Futures markets continue to price in at least a 25-basis point cut with a 50% chance a 50-basis-point cut, with valid arguments for either move. Fed Chair Jerome Powell’s comments following the decision may provide guidance on the nature of this rate-cutting cycle, although his comments at the Jackson Hole Economic Symposium in August provided little new information. The Fed has acknowledged that it remains in restrictive territory and wants to get back to the neutral rate of interest, which it currently puts at around 2.8%. 

Core inflation stuck at around 3%

US headline CPI rose 0.2% month over month in August and 2.5% year over year as core rose 0.3% month over month, higher than expectations. While inflation continues to trend lower at the headline level, core inflation has leveled off at just above 3%. Supercore (goods ex housing) remains sticky at +0.3% month over month, matching July’s rise. 

Real US household income rose 4% in 2023

The US Census Bureau Inflation-adjusted median household income was $80,610 in 2023, up 4% from the 2022 estimate of $77,540 and close to the pre-COVID peak of $81,210 reached in 2019, the bureau said Tuesday. The US consumer has been a bright spot during this economic expansion, with retail sales and housing particularly strong. Consumer spending in the US accounts for approximately 70% of GDP. 

Draghi commission makes recommendations for a more competitive EU  

A commission headed by former ECB President Mario Draghi made key recommendations to increase the competitiveness of the European Union. The recommendations include relaxing competition rules to enable market consolidation in sectors such as telecoms, the integration of capital markets by centralizing market supervision, greater use of joint procurement in the defense sector, and a new trade agenda to increase the EU’s economic independence. The report suggests that if reforms are not adopted, Europe will fall further behind the US and China. There have been calls for €750 to €800 billion in additional annual investment and the issuance of “common safe asset,” i.e., joint EU bonds.

QUICK HITS

As expected, the European Central Bank cut interest rates to 3.5% from 3.75%, its second rate cut in three months. Growth in the euro area has remained weak, with industrial production in Germany a particular drag.

The eight largest systemically important banks in the United States face a 9% increase in capital requirements rather than the original 19% proposed. The revised Basel III plan will be subject to a 60-day comment period. Final adoption may not take place until next year.

Goldman Sachs strategists say US stocks are unlikely to slump 20% or more as the risk of a hard landing remains low against the expected Fed rate cut.

US consumer borrowing increased by the most since November 2022 in July, helping to boost retail sales. Borrowing went up by $25.5 billion compared with an estimated rise of $10.4 billion.

Continuing her campaign for the US presidency, Vice President Kamala Harris promised to end subminimum wages for tipped workers and proposed a higher federal minimum wage for tipped workers.

Former President Trump escalated his tariff threat, vowing to protect the US dollar and warning countries to stick with the greenback in trades or face a 100% levy if he is reelected president.

The 30 September US government funding deadline looms.

Bank of Canada Governor Tiff Maklem stated that it is reasonable to expect further rate cuts if the economy evolves as forecast. Hiring has been weak, creating slack in labor markets, which could lead to a further easing of inflation. He suggested it might be appropriate to cut rates more quickly if downside risks materialize. 

China CPI rose 0.6% year over year in August, while PPI fell 1.8%. The country could see a deflationary spiral if inflation levels fade lower. 

China exports rose 8.7% in August while imports rose 0.5%. Chinese companies are trying to increase exports amid weak domestic consumption and increasing tension with global trade partners. 

Brent crude fell below $70 for the first time since December 2023 on Tuesday and remained there through Friday. 

Volkswagen will terminate a German job security agreement at the end of the year. 

Ireland will receive a €13 billion windfall after the European Court of Justice ruled that Apple underpaid its corporate taxes over a number of years. Ireland spent millions in legal fees to oppose the EU’s contention that it gave Apple a sweetheart deal. 

US 10-year breakevens, a market-based measure of inflation expectations, have fallen to 2.07%. Breakevens peaked at just over 3% in April 2022. 

Bank of Japan board member Junko Nakagawa says he thinks the degree of monetary easing will be adjusted if the outlook for Japan’s economy and inflation is realized, adding that the current level of real rates is extremely low. The yen firmed to its strongest level of the year near, 140.70, after the comments. 

UK GDP was flat on a month-over-month basis in July but rose 0.5% on a quarterly basis. 

THE WEEK AHEAD

Highlights of economic data and events scheduled for next week:

Monday: Inflation in the UK is expected to have risen 2.2% on a year over year basis. Lower energy prices have been keeping headline inflation in check, although core CPI is expected to have risen 3.5%. 

Tuesday: Japan exports are expected to have increased by 10.4% year over year, with yen weakness providing a tailwind to export prices. 

Wednesday: The Fed will release its policy rate decision, which is expected to be at least a 25-basis-point reduction. 

Thursday: The Bank of England is expected to hold its policy rate at 5% after cutting 25 basis points in August. 

Friday: The German producer price index is expected to fall 1% on a year-over-year basis. 

EARNINGS NEWS

Analysts’ expectations of earnings growth for the third quarter have modestly declined recently, according to FactSet. Earnings in the energy and industrial goods and services sectors saw the largest downward revisions. Weak energy demand from China and strong supply are expected to weigh on energy prices in the coming months.