In June, Canada's merchandise exports increased 5.5%, while imports rose 1.9%. Consequently, after three consecutive monthly deficits, Canada's merchandise trade balance with the world moved from a deficit of $1.6 billion in May to a surplus of $638 million in June. The June surplus is close to the typical bounds for monthly revisions applied to imports and exports in subsequent months.

Total exports were up 5.5% in June, the largest percentage increase since February 2024. Overall, 9 of the 11 product sections increased. In June, crude oil and unwrought gold accounted for more than three-quarters of the increase in the value of total exports. In real (or volume) terms, exports rose 3.8% in June.

Exports of energy products were up 11.7% in June, led by higher exports of crude oil (+13.3%). While prices for crude oil exports rose in June, volumes were the largest contributor to the increase. The higher exported volumes were driven in part by higher exports of crude oil to Asian countries. The rise in exports destined to this part of the world reflects increased deliveries of crude oil from Western Canada via the Trans Mountain pipeline, whose expansion was recently completed.

Following a 7.3% decline in May, exports of metal and non-metallic mineral products were up 11.8% in June. Exports of unwrought gold, silver and platinum group metals and their alloys—a category largely composed of unwrought gold—posted the largest increase (+35.3%). In the first half of 2024, large monthly fluctuations were observed in export values of unwrought gold, with the absolute monthly variation rate standing at 28.5% for the year thus far. The geopolitical context and high demand for gold are contributing factors to this volatility. In June, exports of unwrought gold to the United Kingdom rose considerably, driven by higher deliveries of refined gold.

Total imports increased 1.9% to $66.0 billion in June, a level virtually identical to the all-time high seen in June 2022. Overall, increases were observed in 9 of the 11 product sections in June 2024. In real (or volume) terms, total imports increased 1.3%.

After declining 4.2% in May, imports of motor vehicles and parts rose 5.1% in June, contributing the most to the increase in total imports. Imports of passenger cars and light trucks were up 8.2% to a record $6.8 billion in June, a fourth increase in five months. This recent growth occurred amid a recovery from production disruptions and delayed deliveries in the United States in late 2023 and early 2024.

Imports of consumer goods (+3.7%) also contributed to the increase in June. Following two consecutive monthly declines, imports of pharmaceutical products (+16.9%) rose the most, largely driven by higher imports from the United States and Ireland.

These gains were partly offset by lower imports of metal ores and non-metallic minerals (-17.1%) in June. After rising 27.1% in May, imports of other metal ores and concentrates dropped 18.5% in June. As in May, imports of gold for refining and copper ores and concentrates contributed the most to the monthly variation in June.

Exports to the United States were up 2.6% in June, a third consecutive monthly increase, while imports from the United States rose 1.7%. As a result, Canada's trade surplus with the United States widened from $8.8 billion in May to $9.4 billion in June, the largest surplus since November 2023.

After falling 13.0% in May, exports to countries other than the United States rebounded 15.7% in June. Gains were observed in exports to the United Kingdom (unwrought gold), India (crude oil and copper ore) and Italy (aircraft). Meanwhile, imports from countries other than the United States posted a more modest increase of 2.1%. Imports from China (various products), Mexico (light trucks) and South Korea (various products) saw the largest increases in June.

As a result, Canada's trade deficit with countries other than the United States narrowed from $10.4 billion in May to $8.7 billion in June.

After edging up 0.1% in the first quarter of 2024, imports rose 2.0% in the second quarter. This increase was driven by higher imports of motor vehicles and parts (+5.1%) and metal and non-metallic mineral products (+7.9%).

After falling 0.9% in the first quarter, exports were up 1.1% in the second quarter. Exports of aircraft and other transportation equipment and parts (+12.8%) and energy products (+2.0%) contributed the most to the quarterly increase. However, these gains were partly offset by lower exports of motor vehicles and parts (-3.1%). This was the third consecutive quarterly decrease for this product section.

In real terms (calculated using chained 2017 dollars), imports increased 0.3% in the second quarter. The product sections that drove the increase in nominal terms also contributed the most in real terms. Meanwhile, real exports fell 0.4% in the second quarter. This decline was led by lower exports of metal and non-metallic mineral products.

Imports in May, originally reported at $64.4 billion in the previous release, were revised to $64.8 billion in the current reference month's release. Exports in May, originally reported at $62.4 billion in the previous release, were revised to $63.2 billion in the current reference month's release.

In June, monthly service exports were up 0.6% to $17.2billion.Meanwhile, imports of services increased 1.6% to $18.3 billion.

When international trade in goods and services are combined, exports increased 4.4% to $83.8 billion in June, while imports rose 1.8% to $84.3 billion. As a result, Canada's total trade deficit with the world went from $2.6 billion in May to $501 million in June.

This week's market turmoil stemming from Japan may have given China's central bank an unlikely assist in its battle to stimulate economic activity.

Like the Japanese yen, the Chinese yuan has been used to make carry trades -- borrowing in currencies of countries with low yields and investing in those with higher ones -- due to China's low interest rates and low volatility. Such trades had created downward pressure on the yuan. But the Bank of Japan's signal of faster-than-expected rate hikes and growing expectations for U.S. rate cuts sparked an unwinding.

The onshore yuan, which moves within a trading band of the exchange rate fixed by the People's Bank of China, jumped from 7.2446 per dollar last Thursday to 7.112 amid Monday's market plunge, hitting its strongest level since early January. It has since fallen back, marking 7.1820 as of Wednesday morning.

The offshore yuan, which moves more freely, surged at one point to 7.0836, the strongest since it touched 7.0748 on May 30. The offshore yuan was trading at around 7.1835 per dollar on Wednesday.

"The rally in the Japanese yen has triggered some unwinding of the carry positions, indirectly benefiting the yuan as well, which is also largely used as a funding currency," said Charu Chanana, head of FX strategy at Saxo, a Danish bank. Falling U.S. yields also fueled some unwinding in carry trades, she said.

Downward pressure on the yuan has been considered a key bottleneck for cutting interest rates, given Beijing's preference to maintain stability and boost its appeal as a global currency. A stronger yuan creates room for the PBOC to further ease monetary policy amid low inflation and a weak housing market.

China cut a string of interest rates in July after lower-than-expected economic growth figures in the second quarter.

"Chinese authorities could certainly take this shift in Fed narrative and strength of the yuan as a green flag for further rate cuts, having recently shifted their focus from supply-side reforms to demand-side stimulus in order to boost consumption," said Chanana.

On the other hand, additional rate cuts could further fuel a bond-buying frenzy that the PBOC has tried to cool. The yield on the 10-year government bond, which moves inversely to price, hit a low of 2.0913% on Monday, according to data provider Wind. In what one economist called a "contradictory" move, China's rate cuts came weeks after the PBOC announced that it had borrowed bonds from banks, sending a signal to markets that it can sell the bonds to keep rates high.

Toshifumi Umezawa, strategist at Pictet Asset Management (Japan), said a key concern was the risk of the yield curve flattening out, which could threaten the business model of banks that borrow in the short term and lend for the long term. That is why the PBOC appears to be shifting the focus of its policy to the short-term seven-day reverse repo rate, he added.

At a meeting last Thursday to lay out its plans for the second half of the year, the PBOC said it will "maintain the basic stability" of the exchange rate and "resolutely prevent the risk of overshooting."

Ju Wang, head of Greater China FX and rates strategy at BNP Paribas, said that "the one-way RMB depreciation view probably is coming to an end at least for this quarter," using the abbreviation for the yuan's other name, renminbi.

On Wednesday, the central bank adjusted the fixing to allow the yuan to weaken against the dollar. This is a reflection of the PBOC being more willing to let market forces work, as the dollar could soon lose steam as expectations build for a Fed rate cut next month, Wang said.

"We are not chasing at the current level," Wang said, as dollar moves could flip-flop amid rate speculation and recession concerns.

The European bank took profits on Monday, closing trades as the spread between the offshore and onshore currency closed.

BNP is in a "holding pattern" on Chinese government bonds, as the current yields of these debts are "complicated," Wang said. The PBOC on one hand needs to stimulate the economy more by cutting rates, but it doesn't want to risk financial instability, with smaller banks potentially booking losses on holdings of long-end bonds.

Wee Khoon Chong, Asia-Pacific macro strategist at BNY Mellon, said the bank is "seeing a neutral" yuan position, citing custodian data from long-term institutional investors. They have been selling China equities and buying China government bonds, he added.

The U.S. goods and services trade deficit decreased from $75.0 billion in May (revised) to $73.1 billion in June, as exports increased more than imports. The goods deficit decreased $2.5 billion to $97.4 billion, and the services surplus decreased $0.6 billion to $24.2 billion.

Exports of goods and services increased $3.9 billion, or 1.5 percent, in June to $265.9 billion. Exports of goods increased $4.4 billion, and exports of services decreased $0.4 billion.

The increase in exports of goods reflected increases in capital goods ($1.9 billion) and in industrial supplies and materials ($1.4 billion).

The decrease in exports of services reflected a decrease in travel ($0.4 billion).

Imports of goods and services increased $2.0 billion, or 0.6 percent, in June to $339.0 billion. Imports of goods increased $1.9 billion, and imports of services increased $0.2 billion.

The increase in imports of goods reflected increases in consumer goods ($2.3 billion) and in capital goods ($2.2 billion). A decrease in industrial supplies and materials ($1.9 billion) partly offset the increases.

The increase in imports of services reflected increases in travel ($0.1 billion) and in maintenance and repair services ($0.1 billion). A decrease in transport ($0.2 billion) partly offset the increases.

Real, or inflation-adjusted, statistics are also available for trade in goods (Census basis). The real goods deficit decreased 2.6 percent in June, compared to a 2.5 percent decrease in the nominal deficit. Real exports of goods increased 3.2 percent, compared to a 2.7 percent increase in nominal exports. Real imports of goods increased 0.9 percent, compared to a 0.8 percent increase in nominal imports.

At its meeting on 18 July 2024, the Governing Council decided to keep the three key ECB interest rates unchanged. The incoming information broadly supports the Governing Council’s previous assessment of the medium-term inflation outlook. While some measures of underlying inflation ticked up in May owing to one-off factors, most measures were either stable or edged down in June. In line with expectations, the inflationary impact of high wage growth has been buffered by profits. Monetary policy is keeping financing conditions restrictive. At the same time, domestic price pressures are still high, services inflation is elevated and headline inflation is likely to remain above the target well into next year.

The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. It will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim. The Governing Council will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction. In particular, its interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission. The Governing Council is not pre-committing to a particular rate path.

The incoming information indicates that the euro area economy grew in the second quarter, but likely at a slower pace than in the first quarter. Services continue to lead the recovery, while industrial production and goods exports have been weak. Investment indicators point to muted growth in 2024, amid heightened uncertainty. Looking ahead, the recovery is expected to be supported by consumption, driven by the strengthening of real incomes resulting from lower inflation and higher nominal wages. Moreover, exports should pick up alongside a rise in global demand. Finally, monetary policy should exert less of a drag on demand over time.

The labour market remains resilient. The unemployment rate was unchanged, at 6.4% in May, remaining at its lowest level since the start of the euro. Employment, which grew by 0.3% in the first quarter, was supported by a further increase in the labour force, which expanded at the same rate. More jobs are likely to have been created in the second quarter, mainly in the services sector. Firms are gradually reducing their job postings, but from high levels.

National fiscal and structural policies should aim at making the economy more productive and competitive, which would help to raise potential growth and reduce price pressures in the medium term. An effective, speedy and full implementation of the Next Generation EU programme, progress towards capital markets union and the completion of banking union, and a strengthening of the Single Market are key factors that would help foster innovation and increase investment in the green and digital transitions. The Governing Council welcomes the European Commission’s recent guidance calling for EU Member States to strengthen fiscal sustainability and the Eurogroup’s statement on the fiscal stance for the euro area in 2025. Implementing the EU’s revised economic governance framework fully and without delay will help governments bring down budget deficits and debt ratios on a sustained basis.

Annual inflation eased to 2.5% in June, from 2.6% in May. Food prices went up by 2.4% in June – which is 0.2 percentage points less than in May – while energy prices remained essentially flat. Both goods price inflation and services price inflation were unchanged in June, at 0.7% and 4.1%, respectively. While some measures of underlying inflation ticked up in May owing to one-off factors, most measures were either stable or edged down in June.

Domestic inflation remains high. Wages are still rising at an elevated rate, making up for the past period of high inflation. Higher nominal wages, alongside weak productivity, have added to unit labour cost growth, although it decelerated somewhat in the first quarter of this year. Owing to the staggered nature of wage adjustments and the large contribution of one-off payments, growth in labour costs will likely remain elevated over the near term. At the same time, recent data on compensation per employee have been in line with expectations and the latest survey indicators signal that wage growth will moderate over the course of next year. Moreover, profits contracted in the first quarter, helping to offset the inflationary effects of higher unit labour costs, and survey evidence suggests that profits should continue to be dampened in the near term.

Inflation is expected to fluctuate around current levels for the rest of the year, partly owing to energy-related base effects. It is then expected to decline towards the target over the second half of next year, owing to weaker growth in labour costs, the effects of the Governing Council’s restrictive monetary policy and the fading impact of the past inflation surge. Measures of longer-term inflation expectations have remained broadly stable, with most standing at around 2%.

The risks to economic growth are tilted to the downside. A weaker world economy or an escalation in trade tensions between major economies would weigh on euro area growth. Russia’s unjustified war against Ukraine and the tragic conflict in the Middle East are major sources of geopolitical risk. This may result in firms and households becoming less confident about the future and global trade being disrupted. Growth could also be lower if the effects of monetary policy turn out stronger than expected. Growth could be higher if inflation comes down more quickly than expected and rising confidence and real incomes mean that spending increases by more than anticipated, or if the world economy grows more strongly than expected.

Inflation could turn out higher than anticipated if wages or profits increase by more than expected. Upside risks to inflation also stem from the heightened geopolitical tensions, which could push energy prices and freight costs higher in the near term and disrupt global trade. Moreover, extreme weather events, and the unfolding climate crisis more broadly, could drive up food prices. By contrast, inflation may surprise on the downside if monetary policy dampens demand more than expected, or if the economic environment in the rest of the world worsens unexpectedly.

The policy rate cut in June has been transmitted smoothly to money market interest rates, while broader financial conditions have been somewhat volatile. Financing costs remain restrictive as the previous policy rate increases continue to work their way through the transmission chain. The average interest rate on new loans to firms edged down to 5.1% in May, while mortgage rates remained unchanged at 3.8%.

Credit standards for loans remain tight. According to the July 2024 bank lending survey, standards for lending to firms tightened slightly in the second quarter, while standards for mortgages eased moderately. Firms’ demand for loans fell slightly, while households’ demand for mortgages rose for the first time since early 2022.

Overall, credit dynamics remain weak. Bank lending to firms and households grew at an annual rate of 0.3% in May, only marginally up from the previous month. The annual growth in broad money – as measured by M3 – rose to 1.6% in May, from 1.3% in April.

The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility remain unchanged at 4.25%, 4.50% and 3.75% respectively.

The asset purchase programme portfolio is declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities.

The Eurosystem no longer reinvests all of the principal payments from maturing securities purchased under the pandemic emergency purchase programme (PEPP), reducing the PEPP portfolio by €7.5 billion per month on average. The Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.

The Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to countering risks to the monetary policy transmission mechanism related to the pandemic.

As banks are repaying the amounts borrowed under the targeted longer-term refinancing operations, the Governing Council will regularly assess how targeted lending operations and their ongoing repayment are contributing to its monetary policy stance.

The Governing Council decided at its meeting on 18 July 2024 to keep the three key ECB interest rates unchanged. The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. It will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim. The Governing Council will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction. In particular, the interest rate decisions will be based on the Governing Council’s assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission. The Governing Council is not pre-committing to a particular rate path.

In any case, the Governing Council stands ready to adjust all of its instruments within its mandate to ensure that inflation returns to its medium-term target and to preserve the smooth functioning of monetary policy transmission.

The Federal Reserve’s (Fed’s) dual-mandate focus has shifted attention to the labor market which appears to be losing steam, stoking fears of a sharper U.S. economic slowdown and triggering a sell-off in risk assets globally.Disappointing data could front-load the Fed’s policy action towards the neutral rate, with markets re-pricing for larger cuts at the remaining FOMC meetings this year.Portfolios should be well diversified across both equities and fixed income, and remain appropriately balanced across both U.S. and global equities.

The broadening focus of the Federal Open Market Committee (FOMC) last week on the labor market put the spotlight on a slew of labor market data that came through last week. Overall, the signals from the incoming data pointed to a labor market that is losing steam rather quickly, bolstering the case for the central bank to deliver its long-awaited monetary policy cut at its meeting next month, on Sept 17-18. This comes as markets have repriced for larger policy rate cuts in subsequent meetings following the conclusion of the FOMC meeting last week. In recent days, we have witnessed large moves across major indices, with the next few months likely proving to be volatile as markets reassess incoming data for guidance on the timing and magnitude of the policy rate cuts.

While the Fed held rates steady last week as expected, the Committee notably stated its focus on both its maximum employment and price stability mandate, a departure from previous statements which focused primarily on inflation risks. There were a few adjustments in terms of the description of the labor market in which the Committee had noted that job gains have moderated, and that the unemployment rate has moved up recently, but remains low. Chairman Jerome Powell also highlighted the broadness of recent disinflation, which permits the Fed to be slightly less focused on inflation and more attentive to growth and labor market risks. The incoming data regarding the labor market will be key in guiding the Fed’s reaction function in the coming months.

Turning to the data, the July jobs report delivered a material disappointment. Taking a step back, the unemployment rate has been useful in providing signals on the proximity to a recession. Thus, July’s 0.2% point uptick in unemployment rate to 4.3% triggered the Sahm Rule1, which states that the economy is entering/about to enter a recession when a three-month moving average of the unemployment rate has risen by at least 0.5% point above the minimum 3-month average seen over the prior 12 months (Exhibit 1). While we had expected a modest rise in the unemployment rate and see the labor market as balanced, a look at history demonstrates the possibility that once the unemployment rate starts to rise, it can do so quickly if the economic cycle deteriorates.

At the same time, non-farm payrolls (NFP) rose by 114K, marking the slowest print in over three years with fairly broad-based signs of weakening across the economy as a few services sectors reported declines in payrolls over the month. Other jobs data last week danced to the same tune as labor cost pressures eased last quarter relative to the start of the year when both the employment cost index (ECI) and unit labor costs (ULC) exhibited some strength. Beyond the labor market data, the manufacturing purchasing managers index (PMI) and ISM surveys pointed to softness in the sector. The upshot is that the manufacturing PMI remains comfortably above its cycle low.

However, it is important to recognize that it is not entirely all bad news on the labor front. Labor force grew by 420K, confirming that the economy is still adding workers despite slowing momentum. In other encouraging news, U.S. productivity rebounded in 2Q24, up 2.7% over a year ago.

More recently, softer labor market data has been viewed as a market positive as inflation pressures could diminish through the wage channel. With wages contributing less to the inflation outlook, however, negative news on the labor market might be interpreted as bad news for the economy and raise the prospect of the Fed being behind the curve when it comes to easing policy rates.

Unless we get markedly strong economic data, the series of disappointing data prima facie could accelerate the monetary policy easing cycle. It is no surprise that markets are now pricing in a 50 basis points (bps) cut in September. In response to the recent weakness in the economic data, the Fed is likely to front-load policy easing, with further 50 bps cuts in both November and December, to achieve the neutral interest rate and maintain some degree of flexibility.

Over the last three trading days, TOPIX dropped 20.3%. More notably, the 12% decline on August 5 was the second largest on record, following only that on Black Monday, October 20, 1987. At the time of writing, USD/JPY has fallen close to 9.1% since July 11, when the U.S. released the soft June consumer price index (CPI) print. Carry trades, which arguably have been a key focus, tend to unwind when we witness 1) narrowing interest rate differential and/or 2) increase in FX volatility.

Exhibit 2 illustrates the impact of narrowing interest rate differentials: when interest rate differential narrows, the grey line points downwards, suggesting the difference between 10-year U.S. treasury yield and 10-year Japan government bond yield narrows, thereby leading to a stronger Japanese yen (blue line).

Japanese yen (JPY) shorts peaked for hedge funds when USD/JPY reached 150 (around March this year), but for real money when USD/JPY reached 160 (around June). In June, IMM’s (International monetary market’s) JPY short positions surged i.e. increased JPY selling due to activation of JPY carry trade, which continued amid the possibility that the USD/JPY could aim for 165 JPY as the interest rate gap continued to widen.

The turning point was the release of the U.S. June CPI on July 11 that bolstered the conviction for rate cut expectations by the Fed. Since then, with narrowing interest rate differentials between U.S. and Japan, JPY short positions continued to unwind, impacting overall carry trades globally. Since then, JPY short positions have reduced which contributed to further JPY appreciation.

Meanwhile, Exhibit 3 illustrates the impact of an increase in FX volatility: the implied USD/JPY volatility (grey line) rose due to ongoing geopolitical uncertainties while the investors became risk averse. 1-month implied exchange rate volatility rose to 15.6%, much higher than the year-to-date average of 8.9% and 10-year average of 8.6%. As the market continues to digest the incoming U.S. economic data, the carry unwind may continue while USD/JPY will likely continue to be driven by the outlook for U.S. monetary policy. We also remain cautious about volatility due to uncertainty around political events in Japan and the U.S.

Having said that, Japan’s corporate governance improvements remain a key factor supporting the long-term investment case for Japanese equities. Furthermore, companies could unwind cross-holdings in equities to free up capital and engage in more share buybacks. Meanwhile, further improvement in the macro environment, which we expect in 2H24, will be a key catalyst for sustained Japanese share price gains. At the same time, a stronger JPY may attract international investors who have been put off by the JPY weakness given the hedging costs.

The baseline scenario around U.S. growth remains one characterized by a slowdown rather than a recession. Investors should remain watchful over incoming U.S. labor market data and ensure portfolios are well-diversified to weather the possibility of a greater slowdown. There are a couple of investment implications. Firstly, there is opportunity for investors to add to equities at better valuations in a market that has tended to over extrapolate the weakness in the economy, especially in the event that the data improves. In particular, the focus on quality when it comes to risky assets such as equities should be on the top of the mind for investors. Secondly, in the event of a sharper growth contraction that is met with deeper policy rate cuts by the Fed, investors could extend duration into high-quality bonds which could provide stable returns in the long-term. Thirdly, the imminent monetary policy easing by the Fed could imply the weakening in the U.S. dollar, implying stronger return on non-U.S. stocks. Thus, investors’ portfolios should be allocated across both U.S. and global equities.

The Federal Reserve may be a bit late cutting interest rates, but it's not yet behind the curve in forestalling a U.S. recession.

For all the wild financial swings and furious trading of the past week, markets have yet to price in a Fed monetary policy stance that would actively stimulate the economy at any point over the coming two-year cycle.

While that could highlight investors' lingering concerns about sticky inflation, it more likely reflects their doubts that some deep recession is in fact brewing.

And what it indicates most clearly is that the Fed only has to lift its foot off the brake to keep the expansionary ride going.

Markets were clearly spooked by the surprisingly sharp rise in the U.S. jobless rate last month - and further aggravated by the Big Tech stock shakeout. As volatility spiked, markets have raced to price a series of deep Fed rate cuts over the months ahead.

Just one month ago, futures prices indicated that barely two quarter-point cuts were anticipated over the remainder of the year, but now they show expectations of twice that - some 115 basis points at last count on Tuesday.

Most notable among a series of hastily revised forecasts, U.S. investment bank JPMorgan now projects that we will see two half-point cuts in both September and November, followed by a quarter-point cut in December.

Not for the first time, this may seem a little overcaffienated. And it certainly reflects the market volatility present right now in a holiday-thinned August.

But what's happened further out the curve is perhaps more instructive about what investors expect to see in the full easing cycle ahead.

There's little doubt now the Fed will start cutting next month: its signalling about that was crystal clear at last week's meeting. But where the cutting stops is less obvious.

Looking at futures and money market pricing on Monday, the so-called terminal rate over the next 18 months never got below 2.85%, even during the most extreme part of the day's turbulence

That's a long way down from the current policy mid-rate of 5.38%.

But it's still above where Fed policymakers see the long-term 'neutral' rate - widely seen as their proxy for the fabled 'R*' rate that neither stimulates or reins in economic activity. That median long-run rate is currently 2.8% - after being pushed up 30 basis points by Fed officials this year.

So, if anxious money markets don't think the Fed will be forced to go below that, then the slowdown ahead can't be expected to be that bad - despite all the hand wringing of recent days.

At the very least, it suggests markets remain equivocal about recession and think the removal of policy 'restriction' may be enough by itself to hold the line.

Another way to look at it is to view the 'real' inflation-adjusted Fed policy rate, which is currently 2.5%. That's the highest level in 17 years. It has risen steadily from zero since April 2023 as disinflation has set in.

If the Fed's full easing cycle turned out to be the 250 bps suggested by markets this week - and consumer price inflation were to remain as high as 3% through that period - then the real policy rate would merely return to zero at its lowest.

Bear in mind that the average real policy rate over the past 15 years was -1.4%, so a reversion to zero is not suggesting the Fed is heading for anything like emergency mode.

All conjecture? The Fed has a busy six weeks ahead to clear it all up.

Fed officials speaking this week suggest they're not too worried about recession yet but everything is still on the table policy-wise. They also insist that they will continue to have meeting-by-meeting assessments and that one month of data or market upheaval won't change their minds unduly.

Perhaps cryptically, San Francisco Fed chief Mary Daly said the central bank "is prepared to do what the economy needs when we are clear what that is."

Part of what set recession talk rumbling was the triggering last week of the so-called Sahm Rule, which posits that a 0.5 percentage point rise of the three-month average jobless rate over the low of the prior year typically presages recession.

But even the rule's author, ex-Fed economist Claudia Sahm, downplayed the latest trigger due to pandemic and weather- related distortions still plaguing the jobs data.

And yet, with the labor market softening either way, the Fed still seems set for a September rate cut - a move that will also be accompanied by an update of policymakers projections, including that long-run neutral rate.

And before then, the Kansas City Fed's annual Jackson Hole symposium takes place on Aug. 22-24 - where longer-term Fed thinking tends to get sketched out in more detail.

"It was a mistake that the Fed didn't cut rates last week, but I don't believe it will cause irreparable damage to the economy," reckoned Invesco strategist Kristina Cooper. "This sell-off (in stocks) is a very emotional market reaction that is overestimating the potential for recession."

And the rates market may not even be pricing in recession at all.