21/09/2024 Market Analysis

Week Ahead: U.S. Rate Cuts

Following the U.S. Federal Reserve’s 50 basis-point interest rate cut, the focus now turns to economic data, especially the PCE inflation figures, to gauge the pace of further rate cuts. The Fed’s decision marks the start of a potential easing cycle, following the path of several other central banks.

In Europe, attention is on provisional purchasing managers’ data from the eurozone and the U.K., while Switzerland’s central bank gears up for its upcoming rate decision.

Across the Pacific, the Reserve Bank of Australia (RBA) will meet this week, facing mounting speculation about a possible rate cut. The RBA has consistently pushed back against market expectations, but with key inflation data looming, the market is gradually softening its stance.

Meanwhile, Japan’s inflation data remains focused as it diverges from other G10 economies with a slow and steady approach to tightening monetary policy.

In the currency market, the U.S. dollar weakened against most G10 currencies last week, except for the Japanese yen and Swiss franc. The Dollar Index dropped for the third consecutive week, signalling potential consolidation as the economic calendar lightens. Despite this, U.S. Treasury yields saw a rise, with two-year and ten-year yields increasing after several weeks of declines.

The evolving political landscape in Japan could add a new layer of uncertainty. The upcoming leadership change in the Liberal Democratic Party raises key questions about whether the new leader will call for early elections and whether they will try to influence Japan’s monetary policy.

In summary, central banks across major economies are at a crucial juncture, and the next steps in monetary policy will be closely tied to the latest economic data releases, particularly inflation figures and central bank meetings.

United States of America

The Federal Reserve’s Big Move

The Federal Reserve made a bold decision in September, cutting interest rates by a half percentage point. Now, the focus shifts to upcoming economic data to see how quickly inflation is cooling and how much the economy is slowing. This information will shape expectations for further rate cuts.

Future Rate Cuts in Focus

Analysts expect the Fed to cut rates again in November and December, with the possibility of another large 50 basis-point cut on the horizon. However, Fed Chair Jerome Powell emphasized that future decisions will be driven by incoming data, signalling flexibility in their approach.

Inflation Data on the Radar

This Friday’s U.S. PCE inflation data for August, a key measure the Fed uses to track inflation, will be a crucial point of interest. Many analysts believe this data will confirm that inflation is stabilizing. Additional economic indicators, including the third estimate of second-quarter GDP and the University of Michigan’s consumer sentiment survey, will provide further insight into the state of the economy.

Economic Indicators to Watch

In addition to inflation data, several reports next week will attract attention. These include preliminary manufacturing and services data, consumer confidence reports, durable goods orders, and weekly jobless claims. Each will shed light on how different parts of the economy are performing, especially with the Fed’s focus on the labour market.

Treasury Auctions and Market Movements

The U.S. Treasury will hold several auctions this week, offering notes in various maturities. Meanwhile, the Dollar Index has fallen since the Fed’s rate cut, hitting a low for the year, but it may experience short-term consolidation as market reactions stabilize.

Key Points:

• The Fed cut rates by 50 basis points in September and is expected to cut further this year.
• Upcoming U.S. PCE inflation data will be key in guiding future decisions.
• Additional reports on GDP, consumer sentiment, and labour market data will also be closely monitored.
• The Dollar Index has fallen but could see consolidation in the near term.

Australia

Reserve Bank of Australia Meeting: What to Watch

Markets will be closely watching the Reserve Bank of Australia’s (RBA) policy meeting early in the week, but the real focus will be on Wednesday’s monthly inflation report. This data is expected to show inflation returning to the RBA’s 2% to 3% target range for the first time in over two years.

Inflation Trends and Core Focus

Although headline inflation may appear to be under control, the RBA is likely to downplay its significance due to government cost-of-living rebates contributing to the fall. Instead, the central bank will focus on core inflation, which is expected to remain elevated. However, if core inflation falls to around 3.4% as some economists predict, it would indicate a positive trend and increase expectations for a rate cut.

Market Expectations for Rate Cuts

Despite the cautious tone of the RBA, financial markets are pricing in an 80% chance of a rate cut by the end of the year. However, many economists think the central bank may hold off until 2025. The RBA has emphasized that they won’t wait for inflation to fall back into the target range before cutting rates, acknowledging the time lags involved in monetary policy decisions.

Market Reactions

The Australian dollar has performed well, gaining nearly 1.5% last week, but it lost some ground before the weekend. Resistance levels for the currency are expected between $0.6870 and $0.6900. The RBA’s policy decisions and upcoming inflation data will likely drive further movement in the currency markets.

Key Points:

• Markets are closely watching the RBA’s policy meeting and monthly inflation data.
• Headline inflation may return to the target range, but core inflation remains the central bank’s focus.
• Financial markets see an 80% chance of a rate cut this year, but economists suggest it may be delayed until 2025.
• The Australian dollar has shown strength but may face resistance ahead of key economic data.

Canada

Canadian GDP Data in Focus

Canada’s July gross domestic product (GDP) figures are set to be released on Friday, and recent strong retail sales data might provide a boost. However, overall, Canada’s economy has shown signs of weakness. Analysts caution that despite a possible lift from retail sales, the broader economic outlook remains fragile.

Bank of Canada and Rate Cut Expectations

The Bank of Canada has already cut interest rates three times this year, making it one of the more aggressive central banks globally. There are two more meetings scheduled for 2024—one in October and another in December. While markets anticipate two more quarter-point rate cuts, there’s a growing possibility of a larger half-point move. The odds for a half-point cut in October are just below 50%, but many believe it will happen before year-end.

Inflation Trends and Market Impact

Canada’s recent inflation data showed little movement, with August’s Consumer Price Index (CPI) remaining flat. This trend of moderating price pressures is likely to have more of an impact on market expectations than the upcoming GDP figures. Bond markets have reflected this outlook, with Canada’s two-year yield falling by more than 30 basis points since late August.

Political Uncertainty and Market Reaction

Prime Minister Justin Trudeau may face a no-confidence vote this week, but he is expected to survive as the New Democratic Party (NDP) seeks policy concessions rather than a change in government. The political landscape could create short-term volatility, but it’s unlikely to dramatically shift economic policies in the near term.

USD/CAD Outlook

The U.S. dollar has seen relatively little movement against the Canadian dollar in recent sessions, despite some intraday swings. The next key level to watch is CAD1.3550, with a potential retest of September’s high around CAD1.3650 likely if upward pressure persists.

Key Points:

• Canadian GDP data for July will be closely watched but may not shift market expectations dramatically.
• The Bank of Canada has cut rates three times this year, with more cuts likely before the year ends.
• Inflation remains flat in Canada, which is crucial for future monetary policy decisions.
• Political uncertainty surrounds Prime Minister Trudeau, but a no-confidence vote is unlikely to succeed.
• The Canadian dollar could weaken further if the U.S. dollar continues to gain momentum.

Europe

Eurozone PMIs and ECB Rate Outlook

On Monday, provisional purchasing managers’ surveys (PMIs) for September in the eurozone will be closely watched, especially as speculation grows over whether the European Central Bank (ECB) will cut rates again in October. While the manufacturing sector is expected to remain weak, the services sector may see a slowdown as the temporary boost from events like the Paris Olympics fades.

Analysts predict that overall eurozone activity will stay just above the growth threshold of 50. A composite reading below 50 could spark increased speculation about further rate cuts from the ECB.

ECB’s Next Move

Inflation remains the key focus for the ECB, and French inflation data this week will provide an early indication of eurozone inflation trends. Analysts expect a significant decline due to lower oil prices and cooling services inflation as the effects of the Olympics fade. This will be crucial for determining the ECB’s next steps on interest rates, especially ahead of the October 17 meeting, where the market has priced in a 50% chance of a quarter-point hike.

Key Data and Bond Auctions

Aside from PMIs, important eurozone data this week includes:

• August money supply on Thursday
• German unemployment data for September
• French consumer spending for August on Friday

Bond auctions will take place across Europe, including Belgium, Germany, and Italy. Germany and Italy are conducting significant bond auctions mid-week, and Italy’s end-of-month auction on Friday will include inflation-linked bonds.

Market Sentiment

The euro has been showing momentum, trading between $1.1070 and $1.1185 last week. The key resistance to watch is $1.12, with further resistance near $1.1275. However, caution arises from the U.S.-German bond spread, which has been narrowing, potentially affecting the euro’s strength.

German Elections and Political Implications

In the political arena, Brandenburg, one of the German states, will hold elections on September 22. The AfD party, which performed well in previous elections, is expected to continue its success. However, a political strategy known as the cordon sanitaire may block the AfD from participating in the state government. Additionally, the BSW party’s surprising performance could influence the election results.

Forward-Looking Surveys

This week, markets will also keep an eye on forward-looking surveys, including:

• German Ifo sentiment survey on Tuesday
• GfK consumer climate survey on Thursday
• Eurozone business and consumer surveys on Friday

These surveys will provide further insight into the economic outlook in the eurozone and could affect the ECB’s rate decisions.

Key Points:

• Eurozone PMIs for September will influence rate-cut speculation.
• French and Spanish inflation data will be crucial for ECB decisions.
• Political elections in Germany add an element of uncertainty.
• The euro faces key resistance at $1.12, with bond yield spreads narrowing.

Japan

Tokyo CPI and Bank of Japan Watch

Friday will bring key inflation data as the core consumer-price index (CPI) for Tokyo, which excludes fresh food prices, is released. Economists expect a 2.0% rise in September year-over-year, compared to the 2.4% rise in August. Tokyo’s CPI is considered a leading indicator for nationwide inflation, making this data particularly significant for the Bank of Japan (BOJ) and the broader economy.

On Tuesday, Bank of Japan Governor Kazuo Ueda will address business leaders in Osaka, a hub for manufacturing. This will be an important event as Ueda is expected to answer questions from local executives and hold a press conference, which could provide insights into the BOJ’s outlook on monetary policy.

Political Developments and Policy Implications

Japan’s LDP (Liberal Democratic Party) leadership contest will culminate on September 23, leading to the selection of a new prime minister. The LDP has been the dominant force in Japanese politics for decades, and the outcome is expected to shape Japan’s policy direction, especially regarding national security and fiscal policy. However, differences among LDP candidates in terms of fiscal policy appear minor.

BOJ’s Monetary Policy

The Bank of Japan has maintained a tightening bias, with plans to gradually normalize monetary policy. While a rate hike in October seems unlikely, December could be a more probable timeframe for another increase. The BOJ has also begun quantitative tightening by not fully replacing maturing bonds in its portfolio.

The upcoming August services PPI and Tokyo’s September CPI are critical data points for assessing whether inflation and economic growth align with the BOJ’s expectations. The swaps market is currently pricing in a potential doubling of the overnight rate from its current 0.25% level over the next 12 months.

USD/JPY Outlook

The dollar-yen exchange rate closely mirrors movements in U.S. 10-year Treasury yields. As U.S. rates edged higher, the dollar also recovered against the yen last week, after bottoming around JPY139.60. With Japanese markets closed for a national holiday on Monday, the dollar may target JPY145.65 in the coming days, assuming U.S. rates firm up.

Key Points:

• Tokyo CPI is expected to rise 2.0% in September, a key indicator for nationwide inflation.
• Bank of Japan Governor Ueda to address business leaders in Osaka on Tuesday.
• LDP leadership contest concludes on September 23, with fiscal policy direction at stake.
• BOJ likely to raise rates by December, with tightening already underway through quantitative tightening.
• Dollar-yen exchange rate is sensitive to U.S. 10-year yields, with the potential for further recovery toward JPY145.65.

New Zealand

On Monday, market attention will turn to New Zealand’s trade figures for August. These numbers will provide important insights into the current health of the economy, particularly following recent reports indicating that the economy contracted less than anticipated in the second quarter.

Switzerland

Swiss National Bank’s Rate Decision Looms

On Thursday, the Swiss National Bank (SNB) is anticipated to announce its decision on monetary policy, with expectations leaning towards a 25 basis-point cut to the key policy rate, bringing it down to 1.0%. This would mark the third consecutive reduction in the current cycle that began in March.

Influencing Factors

The decision is likely influenced by the strengthening of the Swiss franc since the last meeting in June, alongside disappointing economic data from Germany, which is Switzerland’s primary export market. Analysts at UniCredit Research suggest these factors will push the SNB toward a rate cut, as the central bank aims to support economic activity amidst challenging conditions.

Market Expectations

The swaps market currently indicates expectations for nearly 50 basis points of additional cuts over the next 12 months, suggesting that market participants foresee further easing in monetary policy.

Currency Movements

The euro has performed well against the Swiss franc, rising for the second consecutive week and reaching a monthly high of around CHF0.9490. Should this trend continue, there is potential for the euro to test the August high and the 200-day moving average just below CHF0.9600.

Key Points:

• SNB expected to cut the policy rate to 1.0% on Thursday.
• Strengthening Swiss franc and weak German data are influencing factors for the decision.
• Market anticipates further cuts, with nearly 50 bp expected over the next year.
• Euro continues to gain against the Swiss franc, potentially reaching levels near CHF0.9600.

United Kingdom

U.K. Economic Data in Focus

This week, attention will shift to the U.K. provisional purchasing managers’ surveys for the manufacturing and services sectors, set to be released for September. In a generally quiet week for U.K. data, these figures are anticipated to provide insight into economic health.

Bank of England’s Stance

The Bank of England (BoE) opted to hold interest rates steady this month, signalling a slower pace of rate cuts compared to the Federal Reserve and European Central Bank. The robust performance of the U.K. economy supports this cautious approach.

PMI Expectations

Analysts predict that the PMI data will reflect steady expansion in the manufacturing sector, indicating a continued outperformance relative to the eurozone, where manufacturers are facing more significant challenges. However, services sector activity is expected to grow at a slower pace as caution prevails ahead of the new government’s budget scheduled for October.

Upcoming Auctions

On the operational front, the U.K. Debt Management Office will auction a November 2033 index-linked gilt on Tuesday and an October 2031 gilt on Wednesday, aiming to manage the government’s debt.

Market Outlook

Despite the BoE holding rates steady, market sentiment remains optimistic about at least one further rate cut this year, with a roughly two-thirds probability of two cuts before year-end. Current expectations place the base rate at 5.0%, with swaps market projections indicating a decrease to around 3.70% by mid-next year, up from 3.55% just a week ago.

Currency Movements

The stronger-than-expected retail sales report for August may have contributed to the pound sterling reaching a two-year high near $1.3340. Technical indicators suggest a bullish trend, with the next target area projected between $1.3500 and $1.3650.

Key Points:

• U.K. PMI surveys for manufacturing and services are due for release this week.
• The BoE remains cautious, with expectations of slower rate cuts compared to other central banks.
• Manufacturing sector is expected to outperform, while services growth may slow.
• Upcoming gilt auctions are scheduled for Tuesday and Wednesday.
• Market anticipates at least one more rate cut this year, with sterling gaining strength against the dollar.