Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Chief Investment Strategist
Summary: Dollar was hurt from the downside surprise in US jobs and consumer confidence data yesterday, and focus turns to German and Eurozone inflation as well as US PCE and nonfarm payrolls due through the rest of the week. EURUSD could see a short-term bounce if inflation surprises on the upside, bringing ECB rate hike bets higher but a sustained boost remains unlikely.
Markets took comfort in the weaker US economic data yesterday in a typical bad news is good news reaction. Both the US JOLTS job openings and consumer confidence data were weaker-than-expected.
US JOLTS job openings report showed a sharp slowdown in job openings and quit rate. Number of job openings edged down to below 9 million and came in at 8.83 million in July from 9.16 million in June, which was also revised lower from 9.53 million earlier. July JOLTS was below consensus and the lowest since March 2021, but remains above the pre-COVID levels of ~7mn. The quits rate edged down slightly to 2.3% from 2.4% in the prior report, taking it to the lowest since January 2021. Powell’s favorite measure, number of jobs per unemployed persons, also slid to 1.51 from a peak of 2.01 in March 2022. There was also a sharper-than-expected decline in the US consumer confidence. August consumer confidence was at 106.1, much beneath the expected (116.0) and the downwardly revised 114.0 in July. The Present Situation index dipped to 144.8 (prev. 153.0), while Expectations declined to 80.2 (prev. 88.0), back near the recession threshold of 80.
These numbers are one of the first indications that Fed’s tightening campaign is having an impact on the economy. Lower job openings and lower quit rates suggest that workers will be less confident in their ability to find new employment at higher wages, so that will reduce the churn in labor market and puts a lid on wage pressures. This also points towards a weaker consumer spending outlook, but markets cheered the fact that this data would bring a prolonged pause in the Fed tightening cycle, and perhaps even an earlier start of the easing cycle. Market pricing for rate hikes later in the year have trimmed, while rate cut expectations have advanced to June 2024 from July earlier. US Treasury yields created with 2-year down 15bps and 10-year down 8bps. This brought a reversal in the US dollar after several weeks of gains, but question now is whether US data is as bad or worse than Europe and who gets a recession first?
Focus from here will turn to more key data due this week to shape the sentiment around whether the Fed has achieved the prefect landing or whether there are reasons to start getting concerned about the economy.
Today’s focus will be the second release of US Q2 GDP which is likely to stay strong given it is backward-looking. We also get the ADP employment survey for August, which if again below consensus expectation of 195k (prev. 324k) could bring some further downside in the greenback. The leisure and hospitality sector is still hiring, and July ADP data as well as JOLTS data yesterday showed larger job openings in this sector. If the pace of hiring in leisure continues to offset the slower hirings elsewhere, then a clear weakening in the labor market may still need to wait.
Later in the week, focus turns to jobless claims, July PCE inflation data and August nonfarm payrolls. Headline and core PCE is expected to stay firm at 0.2% MoM in July while the YoY may be slightly higher at 3.3% (prev. 3.0%) and 4.2% (prev. 4.1%) primarily due to base effects. If actual numbers are higher than expectations, concerns about a sticky core inflation may return, spelling a risk-off and bringing the dollar back higher.
Friday’s August NFP jobs report will be the final test of the labor market ahead of the Fed’s September meeting. Given the Fed’s clear focus on labor market tightness now as a driver of further disinflation, markets will likely be on watch too. Headline jobs growth is expected to slow to 170k in August from 187k previously, but unemployment rate is expected to stay steady at the low of 3.5%. Average hourly earnings growth is expected grow by 0.3% MoM and up 4.3% YoY (prev. 4.4%). This degree of wage growth is still uncomfortably high for the Fed, which ideally would love to see this rate closer to 3% to bring inflation back down to 2%. The USD could see more weakness if we see cooler-than-expected prints, and key support is 103, break below which could mean August low of 101.74 could be tested. Stronger numbers will however bring the focus back on higher-for-longer and may increase the possibility of a rate hike later this year.
Overall, bad US data will continue to be good for markets until the rate hike expectations for November/December are completely priced out. We are moving from a no-landing expectation towards soft-landing, that is unlikely to be a positive environment for the US dollar based on the USD smile theory. Only an eventual weakness in economic activity could trigger concerns around over-tightening and bring a safety bid back to the dollar. The other reason to be cheerful about the US dollar could be if other economies, particularly Europe, see recession concerns to be closer and starker in comparison.
There has been some hawkish messaging lately from ECB members, attempting to keep the September rate hike on the table. But market is still pricing in a September rate hike at about 50% chance. Spain August CPI prints out today showed that it is still too soon to put inflation on the backburner. Germany’s numbers come out later today followed by France, Italy and the Eurozone CPI prints tomorrow. Base effects could bring energy inflation to drop in Eurozone in August despite the recently higher global oil prices, but will lift the core reading. Meanwhile, holiday demand as well as the effects of government subsidies could bump up the services inflation further in the month, keeping overall core CPI sticky. Bloomberg consensus expects headline CPI for the Eurozone to slow to 5.1% YoY from 5.3% YoY in July and core to ease to 5.3% YoY from 5.5% previously, so the expectations are also looking modest and an upside surprise could be a fair possibility.
Higher-than-expected inflation prints can be the trigger for one last rate hike from the ECB next month and that can boost EUR in the near-term. A test of 1.09 for EURUSD may be seen followed by the bigger 1.10. Services inflation is expected to unwind from September and economic outlook is deteriorating quickly, especially in Germany, which means the window for the ECB to tighten further remains rather limited, and so a sustained boost to EUR is unlikely.