BOE Governor Bailey: No Rush for Further Rate Cuts

Remarks of Officials

Central Bank

Summary:

BOE Governor Bailey said at the Jackson Hole Economic Symposium on August 23 that he thought long-term inflation pressures were easing but further interest rate cuts would not be rushed.

On August 23, Bank of England (BOE) Governor Andrew Bailey delivered a speech at the Jackson Hole Economic Symposium, with the main content as follows:

The persistent element of inflation remains, but it is smaller in magnitude now than we expected a year ago. We still face the question of whether this persistent element is on course to decline to a level consistent with inflation being at target on a sustained basis and what it will take to make that happen. Is the decline of persistence now almost baked in as the shocks to headline inflation unwind, or will it also require a negative output gap to open up, or are we experiencing a more permanent change to price, wage and margin setting which would require monetary policy to remain tighter for longer? This framework is now prominent in our thinking on the MPC.

It appears to me that the economic costs of bringing down persistent inflation – costs in terms of lower output and higher unemployment – could be less than in the past. This is consistent with a process of disinflation which is steady and more in keeping with a soft landing than a recession induced process.

Inflation expectations appear to be better anchored, leading me to be cautiously optimistic that inflation will return to target levels. While we are seeing a lower level of inflation persistence than we expected a year ago, we need to be cautious because the job is not completed. Policy setting will need to remain restrictive for sufficiently long until the risks to inflation remaining sustainably around the 2% target in the medium term have dissipated further. The course will therefore be a steady one.

Speech by BOE Governor Bailey

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Kevin Du

Economic

Traders appear to be stepping back from last Friday’s risk-on rally, showing more caution in the Asian session today. The mood in major indices is mixed; with Nikkei trading down by more than -1%, while HSI is showing gain of about 1%. This cautious sentiment is mirrored in the currency markets, where safe-haven currencies like Yen and Swiss Franc have gained slightly alongside Dollar. Risk-sensitive currencies like Aussie and Kiwi are losing some ground.

However, the movements are relatively muted, with no major technical levels being breached. This suggests that markets are merely in a phase of consolidation, indicating that markets are in a holding pattern, digesting recent moves and waiting for the next catalyst.

Today’s economic calendar is relatively light, with Germany’s Ifo Business Climate Index and US Durable Goods Orders being the primary data points to watch. With the UK on a bank holiday, trading might remain subdued for now. But things are expected to pick up as the week progresses, especially with upcoming inflation data from the US, Eurozone, Japan, and Australia.

Technically, EUR/CHF would be a focus today. While the rebound from 0.9209 was strong, it struggled to break through 55 D EMA (now at 0.9577). Decisive break of 0.9448 minor support will argue that this rebound has completed after reject by the 55 D EMA. That would keep the down trend from 0.9928 intact too, and could set the stage for retesting 0.9209 low next.

In Asia, at the time of writing, Nikkei is down -1.09%. Hong Kong HSI is up 1.00%. China Shanghai SSE is down -0.07%. Singapore Strait Times is up 0.01%. Japan 10-year JGB yield is down -0.0162 at 0.879.

Bitcoin to face 66k hurdle as risk-on rally gains traction

Bitcoin surged last Friday and stayed firm throughout the weekend. The cryptocurrency broke through an important near-term resistance level, fueled by broad risk-on sentiment following Fed Chair Jerome Powell’s indication of upcoming monetary easing. It now stands at a critical juncture, where the next move will determine whether it has completed the medium-term consolidation that began in March.

Technically, the break of 62724 confirmed resumption of the rebound from 49008. The strong break of 55 D EMA is also a near term bullish sign. It’s possible that the corrective pattern from 73812 has completed 49008, after hitting 50% retracement of 24896 to 73812 at 49354.

However, to solidify the bullish case, Bitcoin will have to overcome the first hurdle at 61.8% projection of 49008 to 62724 from 57812 at 66288. Rejection by this level will keep the rebound from 49008 as just another leg in the corrective pattern from 73812. On the other hand, firm break of 66288 could prompt upside acceleration to 100% projection at 71528, and build up momentum for eventual breakout from the five-month range.

Gold and Silver bounded in range, awaiting Dollar-driven breakout

Both Gold and Silver are currently still caught in near-term consolidations despite the rally late last week. Both metals have the potential to extend their recent gains, but a more pronounced decline in Dollar may be necessary to provide the needed momentum.

As for Gold, further rally is expected as long as 2470.72 support holds. Firm break of 2531.57 will resume the long term up trend and extend the record run. Next target is 61.8% projection of 1984.05 to 2449.83 from 2293.45 at 2581.30. However, break of 2470.72 will risk deeper pull back to 55 D EMA (now at 2412.87) first.

While Silver has been lagging Gold in its run, there is prospect of a catch up ahead. Corrective pattern from 32.50 has likely completed with three waves down to 26.44, after defending 26.12 resistance turned support. For now, further rise is in favor as long as 28.76 support holds. Break of 29.94 will target 31.73 resistance. Decisive break there will solidify this view and target 32.50 and above. However, break of 28.76 will dampen this immediate bullish case.

Key inflation figures from US and Eurozone loom ahead of September rate cuts

Inflation data will remain the focal point for the markets this week. In the US, PCE inflation report is set to take the spotlight. This report is anticipated to strengthen the case for a rate cut by Fed in September, a move that Fed Chair Jerome Powell has already hinted at. However, with another round of NFP and CPI data due before the next FOMC meeting, the exact size of the initial rate cut remains uncertain. Despite this, Fed officials appear to leans towards cautious, measured approach. So, barring any shocks, a 25 bps is the more probable outcome. Alongside inflation, the markets will also be watching data on durable goods orders, GDP revisions, and personal income and spending.

Eurozone’s CPI flash estimate is expected to be a pivotal piece of data that could seal the deal for a rate cut by ECB in September. This would mark the second cut in the current cycle. Meanwhile, Eurozone’s economic outlook is clouded by concerns over Germany slipping back into a recession. The Ifo business climate index and GfK consumer sentiment survey, thus, will be closely watched for signs of deteriorating confidence in Europe’s largest economy.

In Japan, Tokyo CPI report, often seen as a precursor to national inflation trends, will be a key focus. It may be too early to determine if BoJ will hike rates again this year. Upcoming data on industrial production and retail sales will be crucial. These figures could provide insight into whether rebound of Japan’s industrial sector is gaining momentum in the second half of the year and whether earlier wage increases are translating into higher consumer spending sustainably.

Meanwhile, in Australia, the monthly CPI is expected to show a notable slowdown. However, unless the data reveals significant downside surprises, RBA is likely to hold off on cutting rates this year. Retail sales data from Australia will also be monitored for further clues about consumption trends.

Here are some highlights for the week:

Monday: Germany Ifo business climate; US durable goods orders.

Tuesday: Japan corporate service prices; Germany GDP final; US house price index, consumer confidence.

Wednesday: Australia monthly CPI; Germany Gfk consumer sentiment; Swiss UBS economic expectations; Eurozone M3 money supply.

Thursday: New Zealand ANZ business confidence; Japan consumer confidence; Germany CPI flash; US GDP revision, jobless claims, goods trade balance, pending home sales.

Friday: Japan Tokyo CPI, unemployment rate, industrial production, retail sales, housing starts; Australia retail sales; Germany import prices, unemployment; French consumer spending; Swiss KOF economic barometer; UK M4 money supply, mortgage approvals; Eurozone CPI flash unemployment rate; Canada GDP; US personal income and spending; PCE inflation, Chicago PMI.

Source: ACTION FOREX

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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FED

Remarks of Officials

Central Bank

Last Friday, August 23, Fed Chairman Powell delivered a speech at the Jackson Hole Economic Symposium with the following main points:

For much of the past three years, inflation ran well above our 2 percent goal, and restrictive monetary policy helped restore balance between aggregate supply and demand, easing inflationary pressures and ensuring that inflation expectations remained well anchored. After a pause earlier this year, progress toward our 2 percent objective has resumed. My confidence has grown that inflation is on a sustainable path back to 2 percent.

Today, the labor market has cooled considerably from its formerly overheated state. The unemployment rate began to rise over a year ago and is now at 4.3 percent—still low by historical standards. So far, rising unemployment has not been the result of elevated layoffs. Rather, the increase mainly reflects a substantial increase in the supply of workers and a slowdown from the previously frantic pace of hiring. Job gains remain solid but have slowed this year. Job vacancies have fallen, and the ratio of vacancies to unemployment has returned to its pre-pandemic range. In addition, nominal wage gains have moderated. It seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon. We do not seek or welcome further cooling in labor market conditions.

Overall, the economy continues to grow at a solid pace. However, the inflation and labor market data show an evolving situation. The upside risks to inflation have diminished. And the downside risks to employment have increased. The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.

With an appropriate dialing back of policy restraint, there is good reason to think that the economy will get back to 2 percent inflation while maintaining a strong labor market. The current level of our policy rate gives us ample room to respond to any risks we may face, including the risk of unwelcome further weakening in labor market conditions.

Powell's Speech

Risk Warnings and Disclaimers

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WELLS FARGO

Economic

U.S. Review

Homes Out of Range

Attention this week was squarely focused on Fed Chair Powell's speech Friday morning in Wyoming at the Jackson Hole Economic Symposium. As we discuss in Interest Rate Watch, Chair Powell confirmed that the "time has come" for a monetary policy pivot now that inflation is subsiding and the labor market is displaying signs of faltering. Not surprising, these topics were discussed at length at the most recent FOMC meeting in July, according to the meeting minutes released this week. The key takeaway from the FOMC minutes was that several members expressed a willingness to ease policy back in July, and the vast majority of the Committee voiced support for a rate cut at the next meeting in September. Overall, July's FOMC meeting minutes add credence to our view that September will mark the start of the monetary easing cycle.

One unique challenge the FOMC may run into as it commences with rate cuts is the housing market, where a structural imbalance between strong underlying demand and scarce supply threatens to clog a critical channel through which monetary policy typically works. Amid a growing consensus that a number of rate cuts are on the 2024 calendar, mortgage rates have declined from about 7.2% in May to about 6.5% currently. The drop has yet to lead to a discernable pickup in mortgage demand. The MBA's mortgage application for purchase index fell during July, posted a mild gain in the first two weeks of August and then fell sharply during the week ended Aug. 16.

Home sales also have been slow to respond. Existing home sales inched up during July alongside a modest dip in mortgage rates. That said, the 3.95 million unit pace of resales during the month is still remarkably sluggish and on par with the tepid pace experienced in the aftermath of the Great Recession. The significant contraction in resales since the Fed started tightening policy is partially the result of higher mortgages, and lower financing costs will very likely improve adverse affordability conditions around the margins. A wholesale upgrade seems unlikely, however. Home prices have risen sharply over the past four years and, in July, rose even further with the existing median single-family home price up 4.2% on a year-to-year basis. Looking ahead, homes are likely to stay out of range for many buyers as supply and demand remain misaligned and existing home prices continue climb, a problem we explored in a housing report published this week.

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Meanwhile, the new home market continues to outperform. New home sales jumped 10.6% to a 739K-unit pace in July, helping offset a sharp decline over the previous two months. Home builders have dodged the full effects of restrictive monetary policy by providing mortgage-rate buydowns and other pricing incentives for buyers. As a result, new home sales have held up comparatively well this cycle. The stronger pace of sales during July brought down the supply of available new homes slightly, with months supply falling to 7.5 months. Although improved, new home supply is still elevated, most notably in the major homebuilding markets of the South and West regions. Consequently, builders now appear to be scaling back production for the time being. All told, lower rates should eventually provide a boost to the residential sector, but the positive impulse could take longer to be felt on account of poor affordability conditions and elevated supply of new construction.

Another obstacle the Fed may need to navigate is a foggier gauge on the labor market. This week, the BLS released payroll employment revisions which reduced the level of employment by 818K over the 12 months ended March 2024. As is the case with most economic data, revisions are a necessary fact of life since most data are estimated with the help of surveys for the sake of timeliness and then updated as more concrete information arrives. The relatively large but not unprecedented downward revision likely reflects the many challenges of collecting data in the modern era, including lower survey response rates and increased noise surrounding estimates of the number of businesses opening and closing.

All told, the downward revisions to payrolls provide additional evidence that strains are emerging in the labor market. Initial jobless claims ticked up to 232K during the week ended Aug. 17 from 228K the week prior. Zooming out, the level of initial claims is still relatively low and not consistent with the high readings typically observed during recessions. That said, the trend in claims has drifted higher over the summer, all while other economic indicators continue to flash red. The Leading Economic Index (LEI) again declined in July. Not only has the LEI gone 29 consecutive months without a gain, but the index now sits beneath the low reached in April 2020. A deep contraction in the LEI has served as a reliable predictor of recessions in previous cycles. Clearly, a downturn has yet to emerge despite the long downdraft, but it's still a reminder that the risk of a recession remains unusually elevated. It also suggests that noisier data and structural imbalances, such as in the housing market, are new quirks that the Federal Reserve may need to work around as it seeks to ease monetary policy.

U.S. Outlook

Durable Goods • Monday

Durables demand remains constrained amid restrictive monetary policy and increased economic and political uncertainty. The durables data are also very volatile as orders for large aircraft outlays can dictate overall orders growth. For example, durable goods orders slumped 6.7% in June, but when excluding transportation (aircraft fell around 127%, meaning there were net cancellations in June), orders were up 0.4%. Orders activity has been much more stable when excluding air and defense—as seen in the nearby chart these orders have more or less moved sideways over the past two years.

We expect the usual volatility was again at play last month, and while we forecast a 3.0% pop in new durable goods orders, when excluding transportation that gain may wash away to an essentially flat month for activity. The Bloomberg consensus forecast range is unusually wide for headline orders spanning from a high of +8.2% to a low of -9.0%. Previously released public data from Boeing suggests we should see a rebound in aircraft orders, which will lift the headline. Beyond that, we expect orders activity was mixed and to shake out fairly neutral. It will likely still be some months yet before we see a renewed acceleration in growth.

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Personal Income & Spending • Friday

Consumer spending has remained strong despite a weakening job market. Retail sales rose a whopping 1.0% in July, which in dollar terms amounted to 25% of the total gain from the prior two years in a single month. The latest Quarterly Services Report also suggests services consumption was even stronger in Q2 than previously thought. Is there anything that can stop this consumer?

We forecast broader personal spending to advance 0.5% in July, which would mark the fastest pace of spending in four months. While inflation has faded somewhat from the economic discussion, it still matters for the trajectory of monetary policy. The Fed will be watching the PCE deflator, its preferred price-growth gauge. Based on the previously released CPI and PPI reports, we look for both the headline and core PCE deflator to rise just 0.1% in July. If realized, this suggests real spending rose a solid 0.4% last month.

We've long held the view that the outcome for spending depends on the income of households. Now that liquidity is no longer in excess and the uptake in revolving credit has slowed—as it's become more expensive and difficult to come by—future spending growth comes down to income growth, which is slowing. A moderating labor market could therefore spell trouble for the consumer. We look for personal income to rise 0.2% in July, softer than spending, which suggests we'll see another drop in the personal saving rate, which already slid to its lowest level in 18 months in June.

Overall, we expect consumer spending to moderate in the second half of the year amid a weakening labor market translating to slower wage growth. But households have defied our expectations before. To the extent households do keep spending, it would come at a further deterioration in savings, and thus leave consumers more financially vulnerable over time.

International Review

Adjusting Our Foreign Central Bank & U.S. Dollar Outlook

We published our August International Economic Outlook report this week and made some notable adjustments to our forecasts. More specifically, with the Fed likely on track to cut interest rates in September, we believe select foreign central banks can also either cut more aggressively or initiate easing cycles.

In our view, international institutions tightly integrated into the U.S. economic cycle can potentially pick up the pace of easing. In that sense, the Bank of Canada and Central Bank of Mexico now have scope to lower interest rates with more speed. Also, most central banks across emerging Asia also now have space to ease monetary policy. Currencies across emerging Asia have strengthened recently, and with inflation falling comfortably into target ranges combined with the Fed cutting, regional policymakers can also take a more active approach to shifting toward accommodative monetary policy.

On the other hand, plenty of central banks are still more focused on country-specific economic developments rather than the direction of Fed monetary policy. In that sense, the Bank of Japan is still likely to tighten monetary policy in early 2025. Inflation and fiscal loosening have Brazilian policymakers on the brink of shifting back to a tightening cycle, in our view. Also in Latin America, we believe the Central Bank of Chile is close to ending its easing cycle, while policymakers in Colombia seem committed to a gradual pace of lowering interest rates.

With the Fed likely to front-load its easing, our outlook for the U.S. dollar has also changed. In the short term, we continue to believe the dollar can strengthen against most foreign currencies; however, by the second half of next year, we think this period of U.S. dollar weakness is likely to have run its course, and we suspect the greenback could be stable-to-stronger over the second half of 2025.

By the latter quarters of next year, Fed easing will likely have ended, while other central banks (notably the European Central Bank and Bank of England) will still likely be pursuing monetary easing. Those relative monetary policy trends will, we believe, begin to benefit the greenback by late next year, initially stabilizing and eventually resulting in a stronger U.S. dollar against most foreign currencies.

During this period of dollar stability/strength, we see several foreign currencies as notable underperformers. The New Zealand dollar should, in our view, soften against the U.S. dollar in the second half of 2025, given a subdued local economy and our view for a steady pace of rate cuts from the Reserve Bank of New Zealand through end-2025. The Canadian dollar can also underperform for a similar set of reasons, with local economic growth fairly tepid and the Bank of Canada likely, in our view, to continue on its monetary easing cycle through Q3-2025. In terms of potential emerging markets currency underperformers, the Colombian peso may face downward pressure due to central bank officials likely still cutting the policy rate through Q3-2025. For the Brazilian real, our near-term optimism flips to a more pessimistic outlook as the Brazilian Central Bank will likely pivot to rate cuts in the second half of next year. Also, fiscal challenges will likely re-emerge as Lula gears up for another run at the presidency in 2026.

As we gain more insight into the evolution of U.S. and global monetary policy in the coming months, we will continue to update our U.S. dollar view. If risks of the Federal Reserve delivering less easing than we currently forecast materialize, as mentioned earlier, this could contribute to an even stronger path for the U.S. dollar against foreign currencies over the medium term.

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Riksbank Cuts Rates, Hints at Faster Easing Ahead

Riksbank policymakers lowered the policy rate by 25 bps this week for the second time this year to 3.50%, in line with consensus expectations, and offered dovish commentary in the accompanying monetary policy announcement. Officials highlighted a continued deceleration in inflation and weak economic growth as the driving factors behind their decision to restart the easing cycle.

Policymakers appear to be reasonably confident that inflation can sustainably return to the 2% target, due to developments in CPIF inflation, long-term inflation expectations and other indicators such as producer prices and company pricing plans. Officials pointed to a moderation in wage growth as another supportive factor for inflation returning to target. The central bank's monetary policy update also highlighted recent softness in economic growth, noting a weaker-than-expected GDP growth outcome in Q2-2024, and characterized the country as in a mild recession, with household consumption and housing investment driving the weakness. Labor market developments were described as “subdued.” Riksbank's forward guidance was also more dovish.

Policymakers signaled that “the policy rate can be cut somewhat faster than was assessed in June,” and that if the inflation outlook continues to be consistent with CPIF inflation sustainably returning to target, “the policy rate can be cut two or three more times this year.” This introduces the possibility of one more policy rate cut in 2024 relative to what officials signaled in their June statement. Finally, policymakers touched on risks to the outlook. They called out geopolitics, local and global economic activity developments, and the krona exchange rate as uncertainties in the outlook that could affect their future conduct of monetary policy. While it is possible that some of these risks could result in upward price pressures, we still view this decision and statement as clearly dovish.

As a result, we now expect the Riksbank to deliver faster easing and forecast 25 bps rate cuts at the September, November and December announcements, which would see the policy rate end 2024 at 2.75%. As the policy rate moves closer to neutral, we forecast a more gradual 25 bps per quarter pace in 2025, which would bring the policy rate to a low of 2.00%.

Weekly Economic & Financial Commentary: The Time Has Come for Policy to Adjust_5

Canada GDP • Friday

Canada's economy has been on an overall downtrend for the past few years against a backdrop of higher interest rates and tighter monetary policy. Q1-2024 GDP held up; however, with U.S. economic trends worsening and Canada maintaining strong trade linkages with the U.S., we expect the Canadian economy to continue struggling to gather sustainable momentum. Consensus economists forecast Canada's economy grew ~1.8% on a quarter-on-quarter annualized basis, a similar pace of growth relative to Q1. Looking further out, we believe similar growth rates may be difficult to repeat.

Underwhelming growth prospects combined with falling inflation underpin the Bank of Canada's pivot to easier monetary policy. Should next week's growth data suggest activity is indeed decelerating, we would expect the Bank of Canada to have additional rationale to lower policy rates again at its next meeting. In addition to growth and inflation dynamics, the Bank of Canada may get a tailwind of additional justification for rate cuts from the Federal Reserve. As of now, we believe the Fed will cut policy rates by 50 bps in September and November. Given how closely correlated Fed and BoC monetary policy trends have been historically, BoC policymakers could even see scope for a 50 bps rate cut. Q2 GDP could play a role in that decision as well.

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Eurozone CPI • Friday

Remarkable strides have been made in bringing Eurozone inflation closer to the European Central Bank's CPI target. As of July, headline inflation is 2.6% on a year-over-year basis, within striking distance on the ECB's 2% target. The majority of Eurozone disinflation has come from the goods sector as opposed to the services industry; however, ECB officials have determined that enough progress has been made to shift to more accommodative monetary policy.

For the time being, we believe Eurozone inflation will continue to trend in a way that allows for European Central Bank policy rate cuts. In our view, ECB policymakers will be sufficiently comfortable with disinflation trends to lower interest rates again in September. Going forward, a degree of caution may still be demonstrated by ECB policymakers to defend against any lingering inflationary pressures, but we believe a measured approached to rate cuts will continue through the end of 2025. The lingering concern likely stems from somewhat sticky services inflation, which as mentioned, have yet to soften all that meaningfully. Should inflation tick lower in August, we believe ECB officials will ultimately feel more comfortable delivering our forecast rate cut in September and maintain their easing bias through the end of next year.

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India GDP • Friday

For most of the post-pandemic economic cycle, India's economy has been a notable outperformer. India remains somewhat isolated from global developments—such as geopolitical conflict and China's deceleration—and the Reserve Bank of India (RBI) did not raise policy rates as aggressively as peer central banks. As of now, we believe India's economy can grow well over 7% on a calendar-year basis in 2024. With that said, we are seeing some tentative signs that the extreme economic resilience is starting to fade. Consumer spending has slipped a touch, while activity in India's manufacturing sector has softened.

Q2 GDP data will offer more insight into whether recent data are becoming more trend-like. We will be particularly focused on consumer spending and trade data, as household spending drives India's economy, but exports have become a more sizable contributor to growth. Should consumer spending soften against a backdrop of little fiscal support, and should export growth slow due to global growth challenges, we may be somewhat inclined to lower our GDP forecast. While maybe not the main focus of the GDP report, we will also be curious to see how capital formation trends have evolved post-elections. In a backdrop where Modi's BJP no longer has a majority, we are interested to see if investment flows have been disrupted.

Weekly Economic & Financial Commentary: The Time Has Come for Policy to Adjust_8

Interest Rate Watch

Powell: "The Time Has Come for Policy to Adjust"

Federal Reserve Chair Jerome Powell gave a widely anticipated speech today at the Kansas City Fed's annual conference in Jackson Hole, Wyo. The Fed Chair did not address specific policy actions the FOMC may take at its next meeting on Sept. 18. But his meaning was crystal-clear from one sentence in the speech: "The time has come for policy to adjust."

Powell started his remarks by noting that the Federal Open Market Committee (FOMC) has been focused for much of the past three years on bringing inflation back to the Fed's 2% target. In that regard, the FOMC has largely been successful. As measured by the year-over-year change in the personal consumption expenditures (PCE) deflator, consumer price inflation is running at 2.5%. The annualized rate of change in the PCE deflator of only 1.5% between March and June (most recent data) indicates that inflationary pressures should continue to recede. Excluding the volatile components of food and energy prices, the core PCE price index was up 2.3% at an annualized rate over the past three months. Importantly, Powell said "my confidence has grown that inflation is on a sustainable path back to 2 percent."

Turning to the labor market, which is the other objective of the Fed's dual mandate, Powell noted that the jobs market "has cooled considerably from its formerly overheated state." He went on to state that "all told, labor market conditions are now less tight than just before the pandemic in 2019—a year when inflation ran below 2 percent." The Fed Chair added that "it seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon." Furthermore, he stressed that "we do not seek or welcome further cooling in labor market conditions." In sum, "the upside risks to inflation have diminished. And the downside risks to employment have increased."

In short, the FOMC will cut rates on September 18. The question is by how much? We currently look for a 50 bps rate cut on September 18, but we readily acknowledge that the size of the cut (25 bps or 50 bps) will depend crucially on economic data between now and September 18. In that regard, Powell noted in today's speech that "the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks." In our view, the most important data release between now and the next FOMC meeting will be the August labor market report, which is slated for release on September 6. If the report shows continued weakening in the labor market in August, then a 50 bps rate cut will likely be in play. On the other hand, signs that the labor market has remained solid likely would lead the FOMC to opt for only 25 bps.

Looking further ahead, we see significant policy easing in the coming months and quarters As we discussed in our August 4 update of our interest rate forecast, the stance of monetary policy, as measured by the real fed funds rate, is quite restrictive at the present time. By our reckoning the FOMC needs to cut rates by 200 bps or so "to get back to the vicinity of neutral." Depending on the incoming data, the Committee may very well opt for 25 bps on September 18. But in our view, the FOMC is on the cusp of a significant easing cycle in coming months.

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Credit Market Insights

What Is Driving the Growth in Bankruptcy Filings?

The rate of businesses filing for bankruptcy has picked up significantly in 2024 and is currently at its highest level since the global financial crisis. In the 12-month period ended June 30, the number of businesses filing for bankruptcy rose 40.3%, from 15,724 to 22,060. What is driving this growth in business bankruptcy, and is it something we should be alarmed about?

The pickup in bankruptcy filings likely stems, at least in part, from deteriorating credit quality and lower interest coverage ratios. Elevated interest rates have led to a material rise in interest expenses in the non-financial corporate sector (NFC), mostly on loans. Strong fixed-rate corporate bond issuance during the pandemic has helped to keep the effective rate on corporate debt securities low, which has limited the pass-through of higher interest rates to the largest corporates which have the easiest access to capital markets. Non-investment grade firms, which have less capacity to issue bonds, have thus felt the pinch of higher borrowing costs and tighter business loan conditions more than the largest corporates. Indeed, the share of small businesses that have reported credit is harder to obtain has shifted higher over the past few years.

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The elevated growth rate of business bankruptcy filings also likely reflects a normalization to pre-pandemic levels. The 22K filings from the latest data remain on-par with the roughly 23K claims averaged from 2017-2019. Furthermore, the current level of business bankruptcies remains far below the level reached at the height of the global financial crisis. There may be cause for alarm should the rapid pace of bankruptcies continue through the rest of this year, but currently, the level is in line with what was seen before the pandemic.

We look for the Federal Open Market Committee to cut its target range for the fed funds rate by 125 bps this year, followed by 75 bps in 2025, which if realized, would bring the fed funds rate target range to 3.25%–3.50% by next summer. Real GDP growth is poised to run below its prior cycle’s trend in the next few quarters as policy easing slowly filters throughout the economy, but lower borrowing costs should eventually provide some relief to businesses and strengthen consumer spending growth in the second half of 2025. We suspect the aggressive pace of monetary policy easing will also keep unemployment at bay and support steady monthly job gains through 2025. Taken together, we would expect bankruptcy filings to level off in the coming quarters.

Topic of the Week

What a Downward Revision of 818K Jobs Means for the Labor Market

The preliminary estimate for the 2024 benchmark revision to nonfarm payrolls (NFP) announced indicates the level of employment in March 2024 will be revised downward by 818K come the official annual benchmark in early 2025. This would be the largest downward revision since 2009 and would bring the year-over-year payroll growth in March down from 1.9% (as currently reported) to 1.4%. The announcement was in line with expectations (including ours) for a large negative revision; so, what have we learned from the preliminary benchmark and the data that informed it?

Payrolls are not the outlier they once seemed. For much of the past year, one could shake off increasingly concerning signals from other labor market indicators because NFP continuously surprised to the upside, showing a jobs market that was cooling yet still quite impressive. The downward revision of 818K implies payroll growth between April 2023 and March 2024 averaged 178K per month versus 246K as currently reported(on a non-seasonally adjusted basis). That would put job growth roughly in line with its pre-pandemic pace, similar to other labor market data that have returned to pre-COVID levels.

The worst is unlikely to be behind us.

The benchmark does not include a month-by-month breakdown of revisions, but Q1 data from the Quarterly Census of Employment and Wages (QCEW)—the key input to the benchmarking process, also released this week—suggest the slowdown in job growth is ongoing. That is, the sharp deceleration in employment growth in H2-2023 continued in early 2024, and in fact, the gap between the annual growth rates of published NFP and QCEW data widened in Q1.This suggests a sharper loss of momentum in employment growth at the start of this year.

Weekly Economic & Financial Commentary: The Time Has Come for Policy to Adjust_11

Job growth will likely continue to be overstated. The large benchmark revision—often thought of as the total error in the NFP estimate—furthers our hunch that the birth-death factor has been too generous over the past year. Though we expect the boost from the birth-death factor to weaken ahead as the latest net firm formation data is incorporated into the BLS’s model, payroll growth could be overstated for some time. This also means job growth in the past four months (which is not affected by the revision) likely averaged less than the already-modest 154K currently reported.

Plainly, the announced benchmark revision means payroll growth was materially weaker in the 12 months ended March 2024 than was previously reported, further indicating that the exceptional jobs market that followed the pandemic has come to an end. While the labor market remains in decent shape in an absolute sense, further softening will be harder to attribute to “normalization” and instead will look increasingly like outright weakness in our view. In the Fed's view, the downward revisions were not a complete surprise, but following the BLS announcement, policymakers must grapple with a shorter runway left to pull off a soft landing come their September meeting. Weekly Economic & Financial Commentary: The Time Has Come for Policy to Adjust_12

Weekly Economic & Financial Commentary: The Time Has Come for Policy to Adjust_12

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Daily News

[Quick Facts]

1. Hamas refuses to accept new conditions in a Gaza ceasefire proposal.

2. Fed's Goolsbee says monetary policy is too tight for current economy.

3. Fed's Powell says the time has come for policy to adjust.

4. Bailey says inflationary pressures have eased, but no rush to cut rates.

5. Several ECB officials deliver speeches one after another.

6. ECB's Holzmann says September rate cut isn't foregone conclusion.

7. Gaza ceasefire talks fail again.

8. The biggest clash so far occurs between Lebanon and Israel.

[News Details]

Hamas refuses to accept new conditions in a Gaza ceasefire proposal

On August 25, Osama Hamdan, a senior official of the Islamic Resistance Movement (Hamas), said that Israel was still dragging its feet on the Gaza ceasefire negotiations. He said that the negotiations would focus on the following elements, including adherence to the ceasefire, withdrawal of Israeli forces from the entire Gaza Strip, relief for displaced persons, and a fair agreement on the exchange of detainees.

The delegation had informed the mediators of Hamas's views on the 25th, indicating that Hamas would not accept retractions from what they agreed to on July 2 or new conditions imposed by the Israeli side. Later in the day, Izzat al-Risheq, a member of the Hamas's Politburo, said that the Hamas delegation had left Cairo, Egypt, that evening. Earlier, they met with Egyptian and Qatari mediators and heard the results of their latest round of negotiations.

Fed's Goolsbee says monetary policy is too tight for current economy

"I usually don't like saying, tying our hands before a meeting, but I've been saying for some time, if you take the level of tightness" now seen in the Fed's interest rate target, "you only want to be that tight on purpose if you're trying to cool an overheating economy, and this is not overheating," Fed's Goolsbee said in a CNBC interview last Friday.

Clearly, Goolsbee believes that the current tightening of monetary policy is inconsistent with the current economic situation. It also means that he supports the prospect of the Fed lowering its interest rate target next month.

Fed's Powell says the time has come for policy to adjust

Fed Chairman Powell said on Friday at the Jackson Hole Economic Symposium that the time has come for policy to adjust. But the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.

The Fed's target was to restore price stability. At the same time, a strong labor market should be maintained to avoid a sharp rise in unemployment that characterized earlier disinflationary episodes when inflation expectations were less well anchored. While the task is not yet done, we have made substantial progress toward this goal.

The current cooling labor market was unlikely to be a source of heightened inflationary pressures in the near term, and the Fed "does not seek or want" further cooling of the labor market. The upside risks to inflation have diminished, and the downside risks to employment have increased.

Bailey says inflationary pressures have eased, but no rush to cut rates

Bank of England (BOE) Governor Bailey said on Friday at the Jackson Hole Economic Symposium that the impact of the second round of inflation seems to be less than expected, but it was too early to declare victory. The economic costs of reducing persistent inflation - at the expense of falling output and rising unemployment - might be lower than in the past. This was consistent with a stabilization process of inflation, more in line with a soft landing than a recession-induced process.

Bailey was cautiously optimistic that inflation expectations are better anchored. He thought longer-term inflation pressures were easing but further interest rate cuts would not be rushed because it was still too soon to be sure inflation was beaten. The Bank of England would be cautious in determining the pace of rate cuts.

Several ECB officials deliver speeches one after another

Several European Central Bank (ECB) officials delivered speeches at the Jackson Hole Economic Symposium last week.

Governor Kazaks said that based on the given data, he would be very open to discussing another rate cut in September. But they had to wait and see new forecasts and the August inflation data. Overall, even if inflation continued to move sideways over the next few months, that would be consistent with a further rate cut.

Governor Rehn explained that in terms of monetary policy, the most likely move is to continue cutting rates, and September is easy. After that, everything depends on the data. But it's not about a data point; it,s about the data trajectory.

Governor Vujcic stated that as long as the data would be in line with expectations, i.e. inflation dropping to 2% in 2025, the ECB would be more confident of easing the monetary restrictions. However, the ECB should be cautious and move step by step.

However, Governor Holzmann was more conservative in his speech. He is also regarded as the most conservative Governing Council member, often opposing interest rate cuts.

ECB's Holzmann says September rate cut isn't foregone conclusion

European Central Bank Governing Council member Robert Holzmann stated last Friday that a rate cut next month is not a foregone conclusion, despite some of his colleagues suggesting otherwise. This hawkish Austrian central bank governor said at the Jackson Hole Economic Symposium, "I reserve judgment as always until the decision day, and there is still a lot of data to be released. So, I wouldn't say it's a done deal—though some of my colleagues think so. I believe we need to observe the data more carefully. I'm not opposed to rate cuts; I just don't want to cut rates prematurely."

The market expects the ECB to announce a rate cut at its meeting in three weeks. Besides Holzmann, other officials also said that the decision would depend on the data available at that time. Some believe that the European economy is increasingly weakening, especially in Germany, making another rate cut more likely.

Gaza ceasefire talks fail again

Two Egyptian security sources said there was no agreement on Sunday in the hostage-ceasefire talks that took place in Cairo, with neither Hamas nor Israel agreeing to several compromises presented by mediators, casting doubt on the chances of success in the latest US-backed effort to end the 10-month old war in the Gaza Strip.

Key sticking points in ongoing talks include an Israeli presence in the so-called Philadelphi Corridor, a narrow 14.5-kilometer-long stretch of land along Gaza's southern border with Egypt.

Mediators put forward a number of alternatives to the presence of Israeli forces on the Philadelphi Corridor and the Netzarim Corridor which cuts across the middle of the Gaza Strip, but none were accepted by the parties, Egyptian sources said. Israel also expressed reservations on several of the Palestinian prisoners Hamas is demanding the release of, and Israel demanded they leave Gaza if they are released, the sources added.

Hamas said Israel has backtracked on a commitment to withdraw troops from the corridor and put forward other new conditions, including screening Palestinians for weapons as they return to the enclave's more heavily populated north when the ceasefire begins.

"We will not accept discussions about retractions from what we agreed to on July 2 or new conditions," Hamas official Osama Hamdan told the group's Al-Aqsa TV on Sunday.

The biggest clash so far occurs between Lebanon and Israel

Tensions escalated between Lebanon and Israel in the early morning on August 25. The Israeli military announced that after detecting Hezbollah in Lebanon was preparing to launch a "large-scale" attack, they carried out "pre-emptive" strikes on Hezbollah targets. Hezbollah issued a statement denying this and announced that they had launched a large number of drones and rockets at Israel to retaliate for last month's Israeli airstrike in the southern suburbs of Beirut that killed its military leader Fouad Shukur. Hezbollah also announced that the first phase of the attack was successful. Meanwhile, the Israeli military said it had deployed about 100 fighter jets to attack Lebanon to prevent a larger-scale assault, marking one of the most significant clashes in over 10 months of border conflict.

[Today's Focus]

UTC+8 16:00 Germany IFO Business Climate Index (Aug)

UTC+8 18:45 ECB Governing Council Member Knot Speaks

UTC+8 22:00 ECB Governing Council Member Nagel Speaks

UTC+8 23:00 U.S. Durable Goods Orders Prelim (Jul)

Risk Warnings and Disclaimers

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Owen Li

Economic

Fed chairman Jerome Powell gave his speech at Jackson Hole, Wyoming this past Friday.

The takeaway from this speech is as follows:"The time has come for policy to adjust.""The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks."

But, Mr. Powell ends up warning us,"The limits of our knowledge demand humility and a questioning spirit focused on learning lessons from the past and applying them flexibly to our current challenges."

The bottom line: the Fed will begin to adjust its policy, but...and this is a very important "but"...we, the Fed, will work this policy out depending upon...one...incoming data...two...the evolving outlook...and three...the balance of risks.

Mr. Powell, whatever policy he was promoting, has always tried to err on one side of the situation or the other.

When Mr. Powell and the Fed were trying to provide reserves to the banking system to fight the disruptions of the Covid-19 pandemic and the following recession, Mr. Powell and the Fed constantly worked to err on the side of providing too many reserves so as to reduce the possibility that the economy would become more of a disaster.

As Mr. Powell and the Fed fought inflation over the past two years or so, Mr. Powell and the Fed have always tried to err on the side of being tight for a very long period of time. The Fed has been conducting its policy of quantitative tightening for twenty-nine months.

In adjusting at this time to a new stance, Mr. Powell wants to make sure that he and the Fed are doing the right thing for a sufficient amount of time.

So, Mr. Powell and the Fed are not going to hurry right into a major movement into lower interest rates.

Mr. Powell and the Fed are going to "feel" their way into the future.But, the future appears to be one where the Fed's policy rate of interest is falling.

Here is the picture of how the Fed moved up the effective Federal Funds rate over the past two years.

Federal Funds Effective Rate (Federal Reserve)

The last movement in this policy rate was in late July 2023. So, this policy rate, an effective rate of 5.33 percent, has been in existence for more than one year.

The Fed policy has been composed of two parts: first, the action taken, and second, the "forward guidance" that Federal Reserve officials give the markets.

This approach has, at this time, brought investors' inflationary expectations down to 2.1 percent for the next five- to ten-year period.

So, Fed actions in this part of the financial markets have seemingly convinced the investment community that the Fed is serious about achieving the Fed's 2.0 percent target for inflation in the economy.

But, this is not all that the Federal Reserve has done over the past twenty-nine months. The Federal Reserve has also conducted a policy of quantitative tightening, where it has worked to reduce the size of the Fed's securities portfolio.

Here is the Fed's performance over the past twenty-nine months. The total reduction in the Federal Reserve portfolio has been just under $1.8 trillion. As can be seen, this reduction has occurred in a very steady and persistent manner.

Securities Held Outright (Federal Reserve)

Since June, the Fed has reduced the amount of securities it is letting run off the Fed's balance sheet.

Still, the Fed has more than $3.0 trillion of securities in its portfolio than it did at the end of the time it began to pump reserves into the banking system to combat the effects of the Covid-19 pandemic and the subsequent recession.

The question has always been about when the Fed's securities portfolio was going to return to a "more normal" level. Might Mr. Powell and the Federal Reserve begin a "new" regime of "quantitative" policy as they move forward and "adjust"?

Then there is a third issue that gaining the attention of analysts these days and that is the concern over the reduction in the rate of growth of the M2 money stock.

The M2 money stock has been declining since April 2022. The U.S. economy has never gone through a period of monetary contraction this long without an economic recession taking place.

M2 Money Stock (Federal Reserve)

Economists and market participants are getting worried over the possibility of a recession happening because of what the Federal Reserve has done.

As readers of my posts know, I am not as concerned with this possibility because of all the money the Federal Reserve pumped into the economy as it was fighting the disturbances caused by the Covid-19 pandemic and following recession.

I believe that we need to add a few earlier months to the above chart.

M2 Money Stock (Federal Reserve)

This picture, I believe, puts the current reduction in the M2 money stock into the proper perspective.

The compound annual rate of growth of the M2 money stock during this time of expansion is over 8.0 percent.

Historically, this puts the current period into the class of "excessive" monetary growth.

The only reason, seemingly, that inflation did not get more "out-of-hand" is that people did not use the money stock at the same pace that they formerly had done. That is the velocity of monetary circulation fell.

Velocity of M2 Money Stock (Federal Reserve)

Although the velocity of circulation of the M2 money stock has picked up, it has still not returned to earlier levels.

As a consequence, as I have frequently been writing about, there is a lot of money "lying around" in the financial system.

For example, the commercial banking system has about $3.3 trillion in "vault cash."

This is one reason that the U.S. economy is still performing at a relatively satisfactory rate, and it is also the reason why the stock market has hit all the "historic highs" it did while the Federal Reserve was conducting a policy of quantitative tightening.

In fact, Mr. Powell, in his Jackson Hole speech, reviews the state of the economy and professes that the economy is in a relatively good place.

Economic growth, according to Mr. Powell, "continues...at a solid pace."

"Prices have risen 2.5 percent over the past 12 months."

"The labor market has cooled considerably from its formerly overheated state." This is the result of "a substantial increase in the supply of workers and a slowdown from the previously frantic pace of hiring." Not that bad.

So, the economy is in pretty good shape, but there are issues in the financial sector that need to be dealt with.

It is a time for policy adjustment.But, Mr. Powell reiterates, the Federal Reserve should not go overboard in trying to get everything right in the next few months.

The Federal Reserve will move...but, just don't expect it to move too rapidly.

Source: SEEKING ALPHA

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Danske Bank

Central Bank

Economic

Markets remained calm this week with risk sentiment improving further. Stock markets continued to trade higher taking S&P500 back to the recent highs reached in mid-July and cyclical metal prices increased as well. Bond yields drifted moderately lower in the US while EUR/USD continued higher to the highest level in a year.

In the euro area PMI data for July painted a soft picture as PMI manufacturing dropped from 45.8 to 45.6 (consensus 45.8). While PMI services increased from 51.9 to 53.3, it was driven mainly by a big increase in France related to the Olympics. The weaker manufacturing picture fits with the recent loss of manufacturing momentum witnessed in China. On the euro inflation front this week provided some encouraging news as negotiated wage growth for Q2 dropped to 3.6% y/y down from 4.7% y/y in Q1.

US economic news provided a mixed bag. PMI manufacturing also dropped here – from 49.6 to 48.0, the weakest number since December. PMI service, however, stayed at a robust level at 55.2. The leading indicator from Conference Board softened from -0.2% m/m to -0.6% m/m in July (consensus -0.4% m/m) but the indicator has not performed so well in the past couple of years as the economy has performed better than the indicator suggested. The weekly jobless claims get more attention with the increased focus on the labour market, but they did not provide much news as they were broadly unchanged at 232k versus 228k the week before. BLS released a preliminary annual revision of the employment data and reported a revision of -818k jobs. The market did not react much, though, and a couple of Fed speakers stated it did not change their view of the labour market.

Fed speakers as well as the FOMC minutes generally signalled more confidence with getting inflation back to 2% while some members have increasingly turned their attention to risks in the labour market. However, the overall message is still that a gradual path of rate reductions is expected for now but that it will be data dependent. Hence, a path of moving with 25bp increments is currently seen as most likely. The market currently prices 100bp of easing over the next three meetings, which entails a move to a 50bp cut on one of the meetings, which we do not expect. Should the labour market cool faster than expected, though, the Fed would likely turn to 50bp steps of easing as they start from a quite restrictive stance.

Focus the coming week will be on Flash euro area CPI for August, a key data point ahead of the ECB meeting on 12 September. Focus is on core inflation which we forecast to only marginally decline to 2.8% from 2.85% as service inflation likely remained sticky. The euro area also releases consumer confidence and unemployment numbers. In the US we get consumer confidence from Conference Board, where the labour market questions ‘jobs hard to get’ and ‘jobs plentiful’ will be in focus. Finally in Japan, we will get retail sales, industrial production and Tokyo CPI. China is not releasing any tier-1 data and policy rates will likely stay on hold after they were cut last month.

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