14/09/2024 Market Analysis

Week Ahead: Fed’s Interest Rate Decision Poised to Steer Global Markets

This week, global markets will closely watch several key central bank decisions. The U.S. Federal Reserve remains focused, with uncertainty surrounding whether it will opt for a small or more substantial interest rate cut. Speculation about a 50 basis point reduction has been building, particularly after recent CPI data.

Last week saw significant market reactions, particularly the weakening of the U.S. dollar, which fell sharply against the Japanese yen as speculation around the Fed’s potential move intensified. In the emerging markets, the Mexican peso stood out, gaining 3.4%—the best performance among its peers—boosted by political developments such as the approval of judicial reforms.

The overall market tone remains highly sensitive to the possibility of surprises from the Federal Reserve, with expectations split between a small rate cut and a larger move. As a result, the upcoming FOMC meeting is set to be the central focus for markets this week. Bank of England is expected to stay cautious, though a rate cut is still anticipated later in the year.

United States of America

Key U.S. Economic Data Ahead of the FOMC Meeting

As the FOMC meeting approaches on September 18, a series of important U.S. economic reports will be released, including August retail sales, industrial production, and housing starts. While these figures are unlikely to impact expectations for Fed policy significantly, they will provide valuable insight for economists fine-tuning their Q3 GDP forecasts. August retail sales already showed some weakness with a seasonally adjusted annual rate of 15.13 million units, the slowest since January, although still about 0.5% higher than August 2023. Industrial production might show a slight gain after a 0.6% decline in July, but the broader trend indicates that U.S. manufacturing jobs and output have remained stagnant this year. Housing starts are also under pressure, running about 5% below last year’s pace, which was already 13% below 2022 levels.

Debate Over the Fed’s Rate Cut Size

The upcoming FOMC meeting is a pivotal one, marking the start of the Fed’s easing cycle. The key question is whether the Fed will cut rates by 25 or 50 basis points. Earlier speculation about a larger 50 bp cut waned as market conditions stabilized, but a report on September 12 reignited talks of a more aggressive move. Even if the Fed opts for a smaller 25 bp cut, it could still signal a dovish outlook, leaving the door open for more substantial cuts in future meetings. Historically, Fed Chair Jerome Powell has emphasized the Summary of Economic Projections or “dot plot” as a crucial tool for understanding the central bank’s outlook. In June, the median projection was for one rate cut this year, but several Fed officials suggested the need for two cuts. Updated projections may show a more aggressive reduction in rates, which would raise questions about the Fed’s longer-term plans and whether they are front-loading expected 2025-2026 cuts.

U.S. Dollar Faces Pressure as Market Awaits Fed’s Decision

The U.S. dollar showed signs of weakening last week, with the Dollar Index stalling near 101.85 before dropping to a weekly low of just under 100.90. This shift in momentum reflects the growing uncertainty around the Fed’s rate decision. The potential for a 50 bp cut may deter dollar buying at the start of this week, and markets will remain cautious ahead of the Fed’s announcement. Despite recent volatility, the dollar remains in a fragile position as traders weigh the possibility of larger-than-expected rate cuts.

The Fed’s Rate Decision: What’s at Stake

The Federal Reserve is widely expected to cut interest rates at its September meeting, marking the first reduction since 2020. However, the size of the cut remains uncertain, with markets currently pricing in a 43% chance of a 50 bp cut, according to recent data. This creates a rare moment of uncertainty for the Fed, with investors keeping a close eye on the new “dot plot” to gauge the central bank’s future rate path. Any significant deviation between the Fed’s projections and market pricing could disrupt bond market rallies and increase volatility in the coming weeks.

Upcoming Economic Data to Watch

Investors will closely monitor economic data released before the Fed’s decision. On Monday, the Empire State Manufacturing Survey for September is due, followed by Tuesday’s reports on industrial production and retail sales. Housing starts data will be released on Wednesday, just before the Fed meeting concludes. Any signs of economic weakness could fuel expectations for a larger rate cut. Later in the week, weekly jobless claims and existing home sales data for August will also be released. Additionally, the U.S. Treasury is scheduled to auction $13 billion in 20-year bonds and $17 billion in 10-year inflation-protected notes.

Key Points:

• U.S. economic data this week will provide context but is unlikely to change Fed policy expectations.
• The central debate is whether the Fed will cut rates by 25 or 50 basis points.
• Markets are increasingly uncertain, with a potential larger rate cut weighing on the dollar.
• New Fed projections and incoming economic data will guide future market expectations.

Australia

Australian Employment Data Could Reshape Interest Rate Expectations

This week, all eyes in Australia will be on the release of August’s employment figures, due on Thursday. A sharp rise in the unemployment rate could quickly shift market expectations regarding the next move in interest rates. The Reserve Bank of Australia (RBA) has maintained that the labour market remains tight but anticipates a gradual increase in unemployment over the coming months. If this rise in joblessness accelerates, discussions about a potential rate cut before year-end could gain traction.

August Jobs Report: A Crucial Moment for the RBA

The key event this week is the August jobs report, set for release on September 19. It could provide the RBA with further backing for its resistance to cutting rates anytime soon, even though the market still prices in an 80% chance of a rate cut by the end of the year. So far, Australia has created nearly 320,000 jobs through July, with most of them being full-time roles, compared to 245,000 jobs during the same period last year. Despite this, the unemployment rate has gradually risen to 4.2%, up from 3.9% at the end of 2023, as more people enter the labour force, pushing the participation rate to 67.1% from 66.6%.

Australian Dollar Faces Resistance Amid Economic Uncertainty

The Australian dollar experienced some turbulence last week, falling from a late-August high of $0.6825 to just above its 200-day moving average at $0.6620. However, with the U.S. dollar pulling back, the Aussie recovered to nearly $0.6735 before the weekend. Overcoming resistance in the $0.6750-$0.6770 range could signal a further rally, though there remains some uncertainty about whether the recent upward trend has truly resumed.

Key Points:

• Australian unemployment figures will be closely watched for clues on future rate moves.
• The RBA still believes a rate cut is unlikely, though markets are pricing in an 80% chance by year-end.
• The Australian dollar has shown some recovery but faces resistance, with the economic outlook still uncertain.

Canada

Bank of Canada Poised for Rate Cuts Amid Weakening Economy

The Bank of Canada is widely expected to cut interest rates in its final two meetings of the year, on October 23 and December 11, barring any major economic shock. The recent central bank meeting hints at this possibility, especially after weak job data showed a loss of nearly 44,000 full-time positions and a rise in unemployment to 6.6%. Governor Macklem left the door open for more aggressive rate cuts, potentially even a 50 basis-point move, as inflation continues to moderate. August’s consumer price index (CPI) is expected to rise by only 0.1%, bringing the annual rate down to 2.1% from 2.5%. Additionally, core inflation measures are also expected to decline.

CPI and Retail Sales in Focus

This week’s focus will be on Canada’s August CPI report, which could bolster the case for rate cuts. Other data, such as July’s retail sales, are less likely to influence market expectations. A recovery in retail sales is anticipated after a 0.3% decline in June. Canada’s July portfolio flows will also be reported on September 18, with foreign investors having purchased C$67 billion worth of Canadian bonds and stocks in the second quarter—the highest in two years.

U.S. Dollar’s Movement Against the Canadian Dollar

The U.S. dollar has regained ground against the Canadian dollar after falling in August but has encountered resistance near CAD1.3635. Recent sessions saw a pullback, with the U.S. dollar hovering around CAD1.3565, which aligns with a key retracement level. Despite this, the greenback finished the week slightly higher for the second consecutive week. As long as the CAD1.3550 level holds, a retest of the CAD1.3625-50 range is anticipated.

Key Points:

• The Bank of Canada is expected to cut rates at its October and December meetings, with the potential for a 50 basis-point cut depending on upcoming inflation data.
• Canada’s August CPI report is crucial in shaping rate cut expectations, with inflation forecasted to slow further.
• The U.S. dollar has strengthened against the Canadian dollar, with momentum pointing towards a possible retest of key resistance levels.

Europe

ECB’s Second Rate Cut and Future Speculation

The European Central Bank (ECB) implemented a second rate cut in September, and while many analysts anticipate the next reduction won’t come until December, an October cut remains possible. The elevated services inflation and concerns about the struggling eurozone economy, particularly in Germany, add complexity to the situation. This means that upcoming economic data will continue to be closely monitored.

German Manufacturing Sector Struggles

Germany, a key driver of the eurozone economy, has been particularly impacted by weakness in its export-driven manufacturing sector. The German ZEW sentiment survey for September is expected to show a third consecutive decline in growth expectations. Issues within the auto industry, such as Volkswagen’s recent announcement about potential plant closures, are contributing to this sentiment. Moreover, German industrial production fell by 2.4% in July, and the manufacturing PMI has decreased for three consecutive months, reflecting the challenges the sector faces.

Eurozone Data to Watch

This week will see the release of several critical data points that could influence ECB policy decisions. The eurozone flash consumer confidence indicator, the French business confidence survey, and the final August inflation figures are all expected to provide insights into the region’s economic health. Additionally, several eurozone countries, including Germany, Spain, and France, are set to auction government bonds, which could give further signals on market sentiment.

Euro Exchange Rate Driven by US Factors

Despite the ECB’s actions, the euro’s exchange rate appears to be driven more by developments in the US than in Europe. The gap between US and German yields has narrowed significantly, with the US two-year yield falling faster than Germany’s. This shift is partly due to speculation around a potential 50 basis-point rate cut by the Federal Reserve. Last week, the euro briefly rallied above $1.11, and as the new week begins, the next technical resistance levels to watch are around $1.1125 and $1.1155.

Key Points:

• The ECB cut rates in September, and while another cut in October is not ruled out, most expect a move in December.
• Germany’s manufacturing sector remains under pressure, and the September ZEW survey will be closely watched for further declines in economic sentiment.
• The euro’s movement is more closely tied to US developments, with US yield differentials playing a key role in its exchange rate trajectory.

Japan

Bank of Japan’s Upcoming Meeting

The Bank of Japan (BOJ) is anticipated to keep its interest rates unchanged at 0.25% following its two-day meeting ending on September 20. The focus will be on BOJ Governor Kazuo Ueda’s press conference for potential clues on future policy directions. The BOJ’s decision will come after examining the effects of its July rate hike.

Inflation and Trade Data

On the same day as the BOJ meeting, August’s consumer-price index (CPI) is expected to show that inflation remains well above the bank’s 2% target, with core CPI, excluding fresh food, projected to rise 2.8% year-on-year. Additionally, August trade data and July machinery orders, both scheduled for release on September 20, will be scrutinized to gauge the strength of external demand amidst global economic uncertainties.

BOJ Policy

The market narrative suggests that the BOJ’s policy changes have significantly impacted the yen’s exchange rate. Long-term rates appear to influence the exchange rate more than short-term rates, and the yen is more sensitive to US interest rates than to Japanese rates. Despite expectations that the BOJ will maintain its current stance, the yen has shown resilience. Japanese investors continue to purchase foreign assets, leading to yen sales, while futures market speculators maintain a long position on the yen.

CPI Trends and Currency Impact

While the BOJ awaits the August CPI figures, the Tokyo CPI data already indicates that national CPI likely rose above 3.0%, the highest since last October. Core CPI, excluding fresh food, is expected to have increased to 2.6%, marking its fifth consecutive rise. Despite these inflationary pressures, the yen has remained relatively firm.

Dollar-Yen Exchange Rate Movements

The dollar recently fell to a new low for the year near JPY140.30, partly due to softer US interest rates. The BOJ’s past interventions, including in 2022, have been effective, and current US 10-year yields may stabilize around 3.60%, potentially alleviating some pressure on the dollar. The yen’s resistance levels to watch are near JPY141.00, with significant movement expected if the yen rises above JPY141.50.

Key Points:

• BOJ expected to maintain current interest rates; focus on Governor Ueda’s press conference for future policy hints.
• August CPI and trade data to provide insights into inflation and external demand.
• Market sensitivity to US rates and long-term rates affects yen movement.
• The dollar recently hit a yearly low, with potential stabilization in US yields influencing future currency movements.

New Zealand

New Zealand’s Economic Growth Expected to Confirm Recession

On Thursday, New Zealand will release its second-quarter economic growth data, which is expected to confirm that the economy remains in a slump. This supports forecasts that the Reserve Bank of New Zealand (RBNZ) may need to aggressively cut the official cash rate in the coming months to counteract the downturn.

Prolonged Recession Likely to Trigger Rate Cuts

Most economists are predicting a significant contraction in the economy for the quarter, extending what has been a prolonged recession. With the economy underperforming, there is increasing anticipation that the RBNZ will be forced to take more decisive action to stimulate growth, potentially through a series of rate cuts.

Key Points:

• New Zealand’s second-quarter growth data is expected to confirm the ongoing recession.
• Economists anticipate a significant contraction, adding pressure on the RBNZ to cut rates.
• Aggressive rate cuts are likely over the coming months to support the struggling economy.

United Kingdom

Bank of England’s Upcoming Decision

In late July, the swaps market considered a potential Bank of England (BOE) rate cut, but current expectations have shifted, with odds now below 20%. With only two more meetings scheduled for this year, the market anticipates two quarter-point rate cuts, potentially lowering the base rate to 4.5%. Projections suggest the rate could be around 3.60% by mid-2025.

Inflation and Economic Data

August’s Consumer Price Index (CPI) will be closely watched ahead of the BOE’s meeting. The UK has experienced a slowdown in headline inflation, with an annualized rate of less than 1% for the three months through July. Although this may overstate the disinflationary pressure, a decrease in the year-over-year pace (2.2% in July) is expected in August and September before stabilizing in Q4 and into January 2025.

Core inflation, while more persistent, has shown a notable decrease from 6.9% in July 2023 to 3.3% in July 2024. Services inflation remains stubborn, though it has declined from 6.5% in January to 5.2% in July. Slower wage growth, which was reported at 4.0% year-over-year for the three months through July, is expected to moderate services inflation.

Retail sales data for August will be released next week. Although UK retail sales have averaged a 0.6% monthly increase, consumption has been a drag despite the UK’s strong economic growth in H1 2024. A recovery in consumption is anticipated this quarter, even as overall economic activity slows from 0.6% quarter-over-quarter in Q2 and 0.7% in Q1 2024.

Sterling’s Recent Performance

Sterling’s recent decline took it near $1.30, surpassing the 38.2% retracement of the August rally but falling short of the 50% retracement level near $1.2965. It rose above $1.3150 before the weekend, benefiting from a broad pullback in the US dollar amid speculation of a Fed rate cut. Sterling encountered resistance near $1.3165 and recorded a session low near $1.3115. A retest of the $1.30 level is possible before challenging last month’s high around $1.3265.

Quantitative Tightening

The BOE is expected to maintain its key interest rate at 5.0% during its announcement on Thursday. Despite an August rate cut, the close 5-4 vote suggests a cautious approach to further reductions, with services and wage inflation remaining elevated. Governor Andrew Bailey’s comments indicate a reluctance to cut rates “too much or too quickly.”

The BOE will also outline its quantitative tightening plans for the next 12 months, potentially reducing gilt holdings by £100 billion ($130 billion), which will involve £13 billion in active gilt sales.

Upcoming Economic Events

• August CPI Data: Key for gauging inflation trends.
• GfK Consumer Confidence Survey: Due on September 20, providing insights into consumer sentiment.
• Retail Sales and Public Finances Data: Also scheduled for September 20.
• Gilt Auctions: The UK Debt Management Office will auction the July 2054 gilt on Tuesday and the July 2033 green gilt on Wednesday.

Key Points:

• The BOE is expected to keep rates unchanged, with market projections indicating potential cuts later in the year.
• Inflation data, particularly core and services inflation, will influence BOE policy.
• Sterling has recently faced resistance but may retest lower levels before approaching previous highs.
• The BOE will also update its quantitative tightening plans, with significant gilt sales anticipated.