The Federal Reserve cut interest rates by -0.5% last week, the first reduction in the Fed Funds rate since March 2020. Other central banks kept rates on hold but provided a more dovish outlook. The US dollar weakened, and the gold price reached a new all-time high.
The RBA is expected to keep rates on hold tomorrow ahead of an anticipated drop in the ABS’ monthly CPI estimate on Wednesday.
The latest flash PMIs are due out tonight, ahead of US consumer confidence, PCE inflation, the IFO surveys and updated OECD forecasts later this week.
A half-point cut from the Federal Reserve dominated the market news last week. After the previous Friday’s Wall Street Journal article suggested that the FOMC would likely consider a -0.50% cut, the move was not totally unexpected. However, the market had previously priced a -0.25% cut, and the reasons for the larger reduction were not entirely clear, prompting the first dissent from a Committee member since June 2022.
At the press conference, Jerome Powell explained that the circumstances that led to the FOMC setting the Fed Funds rate at 5.25% to 5.50% in July last year had evolved significantly. Fourteen months ago, core PCE inflation was still above +4.0% yoy, much further from the Fed’s 2% target than the latest +2.6% reading. The Fed Chairman said that he had now gained the necessary confidence that inflation is on a sustainable path back to 2%, even though the August figure is expected to rise to +2.7% yoy when released this Friday.
At the same time, economic growth appears to be slowing, and the risks between inflation and full employment, the other component in the Fed’s dual mandate, have become more balanced. Unemployment is now forecast to peak at 4.4% next year, up from 4.2% in the June forecasts, and the time had come to “recalibrate” monetary policy. Despite the larger cut, there was no sense of panic. FOMC members expect real GDP growth to remain at +2.7% yoy through 2027, compared to a long-run level of +1.8% yoy.
Moreover, the FOMC decided to continue the process of balance sheet reduction and anticipates slowing the pace of easing with -0.25% cuts expected at each of the two remaining meetings this year, with just one additional percentage point of reductions in total next year. In other words, the Fed projections outline a “soft landing” for the economy.
The central banks of the UK, Norway and Japan all kept rates on hold last week. Although rates were left unchanged, the messaging was also dovish. Even the Bank of Japan downplayed the risks of further rate increases, with Governor Ueda saying, “The outlook for overseas economic development is highly uncertain. Markets remain unstable. We need to scrutinise such developments carefully for the time being. As such, we can afford to spend some time in making a policy decision”.
The Swiss and Swedish central banks are both expected to cut by at least -0.25% this week, while the market sees no reason for the RBA to alter policy settings tomorrow. Last week’s August employment report was very much in line with estimates, with the unemployment rate remaining at 4.2%. This week’s monthly CPI estimate is expected to drop from +3.5% yoy to +2.7 yoy as electricity subsidies are factored in for more states.
All major central banks are now easing monetary policy, except for the Bank of Japan and the RBA. However, the market still thinks the Fed has comparatively more to do.
The bond market is pricing a much harder landing for the US economy, expecting another quarter-point before Christmas and a Fed Funds rate of 2.9% in a year’s time. The Treasury yield curve has now decisively “uninverted” between the 2yr and 10yr yields.
The US dollar has weakened substantially as American short-term yields are falling much faster than in other major currencies. Last week, the gold price moved above $2,600 per oz. for the first time in history.
The 2yr Treasury yield is also now trading slightly below the Australian government equivalent, supporting the local currency despite subdued global and Chinese growth forecasts.
At the same time, easier monetary policy and a weaker dollar helped the S&P500 reach a new all-time closing high of 5,714 on Thursday, before slipping by -0.3% on Friday. Australian shares outpaced global indices for the week.
Besides central bank meetings and inflation numbers, investors will get another read on global growth this week. The latest flash PMI surveys are due out today, followed by the IFO surveys and US consumer confidence tomorrow, with the OECD forecasts and US GDP annual revisions out later in the week.
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