Fed Debates Rate Cut Amid Mixed Economic Signals
The past week in financial markets has been dominated by speculation around the potential size of the Federal Reserve's expected interest rate cut at their September meeting. As of early this week, market pricing indicates around an 80% probability the Fed will opt for a larger 50 basis point cut rather than 25 basis points.
Arguments for a 50 basis point cut centre around the Fed funds rate currently being at a very restrictive 5-5.25% level, with the Fed now more concerned about labour market weakness than inflation. Several current and former Fed officials have suggested a strong case could be made to cut by 50 basis points and "rip the band-aid off", rather than gradually lowering rates. However, cautiousness and a desire to remain data-dependent may still lead the Fed to start with a smaller 25 basis point cut.
US economic data has been mixed, making the Fed's job even harder. The NY Empire State manufacturing index surged unexpectedly to an over 3-year high in September. However, retail sales and industrial production data this week will give a clearer readthrough. As economist Paul Krugman argues, the Fed risks staying "too long in the shower" - waiting for data while the economy potentially heads into recession.
In other central bank news, the ECB cut rates by 25 basis points as expected but opened the door to another cut as soon as October if data deteriorates further. High services inflation remains a concern. The Bank of Canada faces a key CPI release that could solidify whether their next hike is 25 or 50bps.
Chinese economic data over the weekend again underwhelmed, with credit growth, retail sales and industrial production all slowing. More forceful policy easing is expected in the months ahead, though potentially not until after the US election.
In markets, the US dollar continued its recent descent, falling against most major currencies. Treasury yields edged lower with the 10-year hovering near 3.6%. Equities were mixed, with tech and growth stocks doing relatively well overall even though Apple was on the back foot. Global smaller companies were the next best performing equity asset class, followed by emerging markets. Oil prices rose around 2% on supply disruptions. Gold hit another record high above $2,580/oz.
Overall, markets have been in a bit of a holding pattern as investors weigh global growth concerns, central bank policy shifts, China risks and the upcoming US election. The size and pace of Fed rate cuts is the dominant focus for now - but one which policymakers themselves appear genuinely uncertain about as they balance inflation and recession risks.
