Over the summer, we have seen big moves in financial markets largely reflecting conflicting views of the US economy. During the first half of 2024, markets were often driven by concerns about persistently high US inflation and the implication that it would be difficult for the Fed to reduce interest rates. However, the last three inflation prints now show core inflation in line with or below the 2% annual target, making it much easier for the Fed to cut (although some concerns about service prices remain). Attention has instead shifted to whether there is not only room but also a need for rate cuts to support the economy. Not least a jump in the unemployment rate to 4.3% in July triggered fears that the US is nearing or already in recession, and market pricing shifted to include quite aggressive rate cuts this year. Earlier this year equity markets reacted very positively to prospects of rate cuts, but in early August, that was overshadowed by a negative reaction to fears of weakness in the economy.
Over the last two weeks, markets have calmed down and expectations for rate cuts have partially reversed. Even though unemployment and other indicators of slack in the US labour market have increased, many other indicators still point to robust economic growth, such as this week’s retail sales data for July. Higher unemployment can also be largely explained by growth in the labour force due to immigration rather than by weak demand, which makes it less of an obvious trigger for recession dynamics. We agree that low inflation has cleared the path for “normalisation” of interest rates from current high levels and for the Fed to consider the labour market and not only inflation, but the process of rate cuts is still likely to be gradual and cautious, with large reactions in interest rate markets to economic news.
As often before, lower bond yields in the US have been reflected in Europe. However, euro area inflation is still clearly above target, and we have not really had signs of cooling labour markets. A lot depends on data, not least upcoming wage data for Q2, but it seems to us that the ECB is more likely than not to wait before cutting rates further.
The recovery in global manufacturing seems to have stalled somewhat, which is also part of the backdrop for increased economic concerns in markets. We continue to see signs of weak growth in China where it seems that initiatives to stimulate demand have not been very successful so far, and more is likely to be needed.
Japan delivered a surprisingly early rate hike in July, and we have seen a strong rally in the JPY in connection with the market turbulence over the last month. After three disappointing quarters, GDP increased 0.8% in Q2, and further rate hikes are likely.
We will get PMI data for most major economies in the coming week. If we see some reversal of weak indicators for manufacturing that we saw in July, that could further dampen recession fears in the market. It is also time for the annual Jackson Hole Economic Policy Symposium which has often been used by the Fed (and occasionally the ECB) in the past to influence market expectations.
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