• FOMC slash rates by 50bps on September 18
   
• Easing to proceed, but at a slower pace
   
• Since the Committee last met, U.S. economic activity has generally surprised to the upside and suggested ongoing resilience

• The FOMC’s September dot plot, the recent string of stronger-than-expected data and policymakers’ comments give no reason to expect another 50 bps cut at the FOMC’s upcoming meeting

• Countdown to election day

• The Fed expected rate cuts in the coming months, but the outcome of the US presidential election could influence their speed and depth

• Expect the FOMC to continue to reduce its policy rate with a smaller 25 bps cut

Easing to proceed, but at a slower pace

The Federal Open Market Committee (FOMC) started its nascent easing cycle with a bang, opting to reduce the fed funds target range by 50bps to 4.75%- 5.00% at its last meeting on September 18. The Committee decided to slash rates because the risks to the Fed’s dual mandate of “price stability” and “full employment” were “roughly in balance”.

The year-over-year rate of “core” PCE inflation, which most Fed officials consider to be the best measure of underlying consumer price inflation, had receded significantly from its peak of 5.6% in February 2022 to 2.6% in July, the last data point the FOMC had when it met on September 18. On the other side of its dual mandate, the labor market was showing signs of softening. Nonfarm payrolls (NFP) rose less than expected in August and the prior two months’ gains were revised down by a combined 86K jobs, reducing the three-month average pace of hiring to 116K from 177K at the time of the July FOMC meeting. The unemployment rate, which had been 3.4% in April 2023, had trended up to 4.2% in August. As Chair Jerome Powell said in his Jackson Hole speech in late August, the FOMC did not “seek or welcome further cooling in labor market conditions”.

Fast forward six weeks, incoming data show that the U.S. economy remains remarkably resilient. Nonfarm payrolls rose by 254K in September, employment gains during the previous two months were revised up by a combined 72K and the jobless rate edged down to 4.1%. The core Consumer Price Index (CPI), which is a different measure of consumer price inflation than core PCE inflation but which is highly correlated with it, rose a bit more than expected in September relative to the prior month with a 0.3% gain. Retail spending in September was significantly stronger.

The Federal Reserve will be entering its pre-interest rate decision blackout period this weekend, with no further updates expected until Chair Powell’s postmeeting press conference on November 7th. The Fed officials we heard from last week stated that the strength of incoming economic data would warrant caution in future policy decisions, but all speakers noted that the trajectory of interest rates would continue to be downward. Market pricing has pulled back their expectations for rate cuts, but they are now realigned with the Federal Reserve’s median projection from the September Summary of Economic Projections

The string of data suggesting that the economy continues to expand at a steady pace and that the labor market is not unravelling have raised questions about whether the FOMC needs to cut again at its upcoming meeting. This week we saw a bumper crop of data releases that will be key inputs to the Federal Reserve’s next interest rate decision.

The U.S. economy posted another solid though slightly disappointing period of growth in the third quarter, propelled higher by strong consumer spending that has defied expectations for a slowdown. The advance estimate for real GDP growth in the third quarter showed that the U.S. economy expanded by 2.8% quarter-on-quarter (QoQ, annualized), below the 3.0% reading for 2Q24. Consumer spending accelerated at its fastest pace since 1Q23, rising 3.7% QoQ while federal government spending exploded higher by 9.7%.

On the inflation front, the Fed's favoured inflation measure, the core PCE deflator, showed that the broad narrative of continued disinflation remains unchanged and suggest momentum continues to trend in an encouraging direction for the Fed. The quarter-onquarter annualised core PCE deflator came in at 2.2%, a notable deceleration from 2Q’s 2.8%. In September, PCE price index rose 0.2% MoM, while core PCE price index, which excludes food and energy, increased by 0.3% MoM. On a year-over-year basis, the headline PCE price index edged down from 2.2% YoY to 2.1% YoY, while core PCE price index remained unchanged at 2.7% YoY. the Fed does not need inflation to be at 2% YoY to allow further rate cuts. it just has to be confident that the month-on-month rates are tracking the right path.

While employment growth remained solid in the third quarter, October’s employment report due out this Friday is expected to show a deceleration in job gains. U.S. job openings fell to the lowest level in more than 3-1/2 years in September and data for the prior month was revised down, pointing to a considerable easing in labor market conditions. Job Openings and Labor Turnover Survey (JOLTS), a measure of labor demand, dropped by 418,000 to 7.443mn by the last day of September, the lowest level since January 2021. Hurricanes and strikes are likely to temporarily obscure the labor market view, with job gains expected to have slowed significantly in October. Nonfarm payrolls probably increased by 115,000 jobs after rising 254,000 in September. That would be the smallest count in six months. The unemployment rate is forecast unchanged at 4.1%. Federal Reserve officials are likely to shrug off October's employment report when they meet on November 7.

Countdown to Election Day

Meanwhile, one of the most anticipated global events of 2024 is now nearly a few days away. As financial markets anxiously await the outcome of the U.S. presidential and congressional elections, we have seen U.S. Treasury yields and the U.S. dollar rise to threemonth highs. The uptick which began earlier last month was initially incited by strongerthan-expected economic data, but recent movements have also likely been driven by the narrowing in the polls for the U.S. presidential election. Given that the election will determine the path of fiscal policy moving forward, and by extension monetary policy, uncertainty related to the outcome is likely to remain a weight on financial markets through to November 5th.

Contrary to expectations of further weakness at the start of the Fed cutting cycle, both USD and Treasuries yield turned back up across October. Instead of weakening in line with the onset of the US Fed rate cutting cycle, the USD staged a counter trend rebound instead. After the Fed kickstarted its rate cutting cycle with an outsized 50 bps cut, the US Dollar Index (DXY) rebounded from 101 to 104. On the surface, this recent USD strength does seem to run counter to previous episodes of USD weakness at the onset of the Fed rate cutting cycle. But there may be several reasons that offered the USD temporary support this time round. Firstly, US activity, inflation and job market indicators were stronger than expected and investors had to dial back their expectations of aggressive Fed rate cuts to a more measured pace. The latest World Economic Outlook (WEO) from the IMF reiterated that the US economic outlook remains strong, with their 2024 growth outlook for the US raised by a further 0.2 ppt to 2.8% and by 0.3 ppt to 2.2% next year. This probably helped to offer support to the USD across October. Second, is the related renewed rise in US Treasuries yield, with 10Y US Treasuries yield rebounding strongly from 3.7% to 4.2% across October. This rise in US Treasuries yield had to do with renewed worries over the widening US fiscal deficit and increasing debt burden as well as increasing risk aversion heading into the US presidential election, as the latest polls suggest that both candidates, Trump and Harris, are running neck-to-neck in a very close race.

Market attention will start to turn toward the US election which draws closer and investors are starting to price in higher odds of a Trump victory at the upcoming US presidential election but for many investors it is too close to call, increasing the potential for movement when the results are announced. Remember that in addition to the presidential election, there will also be votes for the Senate and the House of Representatives. The latest estimates suggest that the main candidates have an equal chance of winning. The Senate is expected to be controlled by the Republicans, while the House of Representatives is expected to go to the Democrats. The most significant impact on the markets would be the consolidation of power in the hands of one party, enabling it to implement its initiatives quickly. The expected outcome would force the president to compromise, which would take time, smoothing out the overall impact but not eliminating it.

Much has been discussed about the policy risks around the US presidential election. In short, Trump’s desired policy mix of lower taxes, easier regulation and higher tariffs, is deemed as expansionary and potentially inflationary for the US economy. These pose upside risk to US Treasuries yield as well as the USD and thus less rate cuts should Trump emerge victorious. On the other hand, Harris’ proposed policy mix is more targeted and perceived to have a more modest impact on both interest rates and the USD. The uncertainty is keeping markets on edge and could result in some wild swings as the election draws closer.

Regardless of the election outcome, both candidates' policies are expected to result in continued wide fiscal deficits and rapidly rising debt levels. This persistent fiscal pressure could keep long-term yields elevated under either administration.

Expect the FOMC to continue to reduce its policy rate with a smaller 25 bps cut

Given that there are no surprises in the data, the Federal Reserve is expected to continue to cut rates at a pace of 25bps per meeting through the end of the year after kicking off its easing cycle with an unusually large half-percentage point cut in September. The first reduction in borrowing costs since 2020 lowered the Fed's policy rate to the 4.75%-5.00% range. It hiked rates by 525bps in 2022 and 2023 to curb inflation. Chair Powell’s remarks on November 7th will be monitored closely for guidance, although they may be competing with the results of the 2024 election for the attention of financial markets. Suffice it to say, markets will not be left wanting for important developments in the coming weeks.

Source: BIMB Securities Research - 1 Nov 2024