07/09/2024 Market Analysis

Week Ahead: Inflation, Rate Cuts & Economic Signals

Investors await U.S. inflation data, expecting potential Fed rate cuts. Recent jobs data reduced the chance of a 50 bp cut at the September FOMC meeting. Treasury yields fell, with the 2-10-year yield curve showing a positive slope for the first time since July 2022.

The European Central Bank is likely to cut rates at its next meeting, while the U.S. 2-year premium over German bonds has declined to 140 bp.

Japan’s Q2 growth data and China’s economic releases are being closely monitored. China’s yuan slipped amid trade tensions, and questions remain about its economic stimulus efforts.

The U.S. dollar is correcting after a sharp August drop, with potential for further recovery despite market volatility.

United States of America

U.S. Inflation Data in Focus

Investors are anticipating the release of U.S. consumer price inflation data for August, which could influence the Federal Reserve’s decision on interest rates. There’s growing speculation that the Fed may start cutting rates at the September 18 meeting and continue through November and December if inflation and economic activity soften.

Expected Inflation Trends

Analysts predict a significant decline in headline inflation for August, while core inflation may stagnate after a period of decline. The money markets suggest there could be a 50 basis-point rate cut if the economy shows signs of a slowdown. The University of Michigan’s consumer survey for September, released on Friday, will provide a valuable snapshot of current economic conditions.

Additional U.S. Economic Data

This week also brings producer prices data and weekly jobless claims. These reports will be closely monitored alongside U.S. Treasury auctions of three-year, 10-year, and 30-year bonds. The recent jobs data showed a slight acceleration in growth and a decline in the unemployment rate, shifting focus to inflation as key economic reports approach.

Fed Policy

The Federal Reserve is expected to decide on its rate policy after assessing key indicators like the Consumer Price Index (CPI) and Producer Price Index (PPI). Current projections suggest a 0.2% rise in core and headline CPI, which may translate into an annualized rate of 1.2% for headline inflation and 2.0% for core inflation. These figures will help shape forecasts for the Fed’s preferred inflation gauge, the PCE deflator.

Dollar Index

The U.S. Dollar Index held steady near 100.50, recovering to 101.40 after hitting a low in late August. Although the dollar’s recent pullback was deeper than expected, a continued correction is possible if the index moves above 101.50.

Key Points:

• U.S. inflation data for August will be critical for the Fed’s rate decisions.
• A 50 basis-point cut is possible if the economy shows significant signs of slowing.
• Upcoming producer prices and jobless claims data will offer more insights.
• Treasury bond auctions and the University of Michigan survey will also be the focus.
• The U.S. dollar shows signs of correction after a recent pullback.

Australia

RBA Speech

This week, all eyes are on the Reserve Bank of Australia’s chief economist, Sarah Hunter, as she delivers a key speech. Investors will scrutinize her words amid increasing pressure on the RBA to cut interest rates, following the lead of global central banks. Despite market expectations, the RBA has ruled out immediate rate cuts, citing persistent inflation and potential upside risks to core inflation.

Political Response to Interest Rates

The ongoing high interest rates have sparked political debate in Australia, with Treasurer Jim Chalmers criticizing the impact on the economy. However, the RBA, led by Governor Michele Bullock, remains cautious. Market resistance to the RBA’s stance continues, although expectations for a rate cut have softened. The Melbourne Institute’s survey of consumer expectations reinforces the RBA’s cautious approach, with inflation expectations rising from 4.1% in May to 4.5% in August, reflecting concerns about underlying inflation pressures.

Currency Movements

Despite these concerns, the Australian dollar has faced selling pressure. After a brief rally to $0.6765, the Aussie fell sharply to $0.6660, posting a 1.4% decline—the largest among G10 currencies last week. Momentum indicators suggest further downside, with near-term targets including the 200-day moving average at $0.6620 and a potential retracement to $0.6585.

Key Points:

• All eyes on RBA Chief Economist Sarah Hunter’s speech amid rate cut expectations.
• The RBA remains cautious on rate cuts due to inflation risks.
• Political pressure is mounting against high interest rates.
• The Australian dollar saw significant losses, with further downside expected.

Canada

Bank of Canada Rate Cut

Following the Bank of Canada’s recent rate cut and dovish outlook, market expectations for further cuts have solidified. Last week’s disappointing August jobs report reinforced these expectations. This week’s economic data, including volatile building permits and a Q2 capacity utilization report, may have less impact. The latter has declined for four consecutive quarters, a trend rarely seen in the past 30 years.

Currency Movements

Despite the Bank of Canada’s dovish stance, the U.S. dollar initially dropped to nearly CAD1.3465, close to its five-month low from August. However, it rebounded to a two-week high above CAD1.3580 after the employment report. The USD/CAD pair faces resistance around CAD1.3585-CAD1.3620, a key technical zone that includes the 200-day moving average and previous congestion levels. Momentum indicators suggest further upside potential for the U.S. dollar, adding to the bullish tone.

Key Points:

• The Bank of Canada cut rates, signalling more cuts may follow.
• August jobs data added pressure, but this week’s reports may be less influential.
• USD/CAD saw a sharp rebound, with technical indicators pointing to further gains.

Europe

ECB Expected to Cut Rates

The European Central Bank (ECB) is expected to announce a 25 basis-point cut to its deposit rate, bringing it down to 3.50%. Despite persistent services inflation, analysts see this cut as likely, with preconditions like slower wage growth and weaker service prices already in place. RBC Capital Markets notes that anything other than this cut would be a major surprise. The ECB is also anticipated to cut the main refinancing rate by 60 basis points to 3.65%, narrowing the spread with the deposit rate.

Inflation and Economic Data

Eurozone inflation data remains a focal point, with the August CPI showing a modest 0.2% increase, bringing the annualized inflation rate to 1.8%. Core inflation is stickier, sitting at 2.8%. Germany and France will release their final August inflation data this week, with Eurozone industrial output figures also on the radar amid concerns over the region’s industrial weakness, particularly in Germany.

Bond Auctions

Several bond auctions are scheduled across Europe, including Germany, the Netherlands, and Portugal. The ECB’s June rate cut began this easing cycle, and markets expect further cuts as inflation slows. The ECB will also update its macroeconomic forecasts, projecting moderate growth and falling inflation through 2026.

Euro Currency Movements

The euro traded higher last week, reaching a seven-day high near $1.1155 after the U.S. jobs report. However, the momentum faded, and the euro settled lower within Thursday’s range. Short-term consolidation is likely as the market awaits the ECB’s decision.

Key Points:

• ECB is expected to cut the deposit rate by 25 basis points to 3.50%.
• Final inflation data from Germany and France and Eurozone industrial output will be closely watched.
• Bond auctions in Germany, the Netherlands, and Portugal are scheduled this week.
• The euro saw gains last week but is likely to consolidate ahead of the ECB meeting.

Japan

Japan’s Q2 Growth

Monday’s release of Japan’s second-quarter growth data will be closely monitored for potential revisions. Japan’s GDP rose by 0.8% in the April-June quarter, rebounding from a 0.6% contraction in the previous quarter. However, Moody’s Ratings has downgraded Japan’s 2024 growth forecast to 0.2%, citing weaker economic performance in the first half of the year.

Political Developments and Economic Implications

Political dynamics in Japan are also under scrutiny, as candidates compete to lead the ruling Liberal Democratic Party. The economy is expected to be a focal point in this leadership race, with concerns about potential fiscal pullbacks impacting Japan’s growth.

Current Account Figures

The release of July’s current account figures will also be in focus, as net exports have posed challenges for Japan’s growth. Meanwhile, the yen’s strength last week made it the top-performing G10 currency, rising 2.7%. If U.S. yields continue to decline, the dollar could face further downside against the yen, with JPY138.75-JPY140 seen as key technical levels.

Key Points:

• Japan’s Q2 GDP data will be reviewed for possible revisions.
• Moody’s Ratings has lowered Japan’s 2024 growth forecast to 0.2%.
• Political developments and fiscal policy are in the spotlight.
• Bank of Japan policymakers’ speeches may hint at future rate hikes.
• The yen has strengthened, with further gains possible against the dollar.

Switzerland

Switzerland is scheduled to hold a bond auction on Wednesday.

United Kingdom

UK Economic Performance and Market Expectations

The UK economy rebounded in the first half of 2024 after a contraction in the second half of 2023. This positive momentum is expected to continue into Q3, potentially leading to a stronger labour market report (September 10) and a solid July GDP report (September 11). Despite the swaps market downgrading the chances of a rate cut at the September 19 Bank of England (BOE) meeting, there is still confidence in at least one rate cut by the end of the year, with a slight preference for two cuts.

Sterling Movements

Sterling surged to nearly $1.3240 after the US jobs data but quickly fell back, ending the European session at a new low of around $1.3110. The currency traded within Thursday’s range and settled below its low, showing a bearish outside down day. The key support level to watch is last Tuesday’s low just below $1.3090; a break below this could signal a continuation of the downside correction following last month’s rally.

Upcoming Data Releases:

• UK Jobs and Wages Data (September 10): Expected to provide insights into labour market conditions but unlikely to alter expectations for the BOE’s rate decisions.
• UK GDP Data for July (September 11): Anticipated to show stronger-than-expected economic performance.
• Industrial Production and Trade Data (September 11): To be released alongside GDP data.
• RICS House-Price Data for August (September 12): Scheduled for Thursday.

Bond Auctions:

UK Debt Management Office Auctions

• March 2045 Index-Linked Gilt (September 10)
• July 2034 Conventional Gilt (September 11)

Key Points:

• UK economic recovery is expected to continue into Q3, with labour market and GDP data closely watched.
• Sterling experienced volatility, with key support levels around $1.3090.
• Upcoming data and bond auctions will provide further insights into the UK’s economic and financial landscape.