Key Takeaways
US employment data released last Friday has revived hopes for rate cuts.
Significantly, the closely watched US ISM services survey was weak in the employment component.
The market is now pricing in two US rate cuts by the year end.
Ahead of then, there is a hurdle this week in the form of inflation data.
In the UK, the Bank of England meets this week and is expected to reduce its inflation forecast.
In Europe, the ECB has effectively promised a rate cut in June.
Pessimism about the prospects for US interest rates cuts has been growing steadily as 2024 has developed. But there was a big change last Friday, reviving hopes that the US Federal Reserve would be able to make significant cuts. US employment data were weak across the board. Even more significantly, the closely watched US ISM services survey was also weak, notably in the employment component.
Strong economic growth in the US, led by the consumer, has taken the pressure off the Federal Reserve to cut rates, especially given disappointing inflation news. Following Friday’s weak data the market has increased the number of interest rate cuts expected by year end, from one to two. A far cry from the 6 cuts being forecast on New Year’s Day, just a few months ago, but a significant improvement nonetheless.
We think there are good reasons for an economic slowdown in the US: the consumer there has been spending ahead of their income. The saving ratio has dropped to just 3.2%, well below the historical norm of 5%. With income growth slowing, consumers will need to retrench. We’re not talking recession here, just a slowdown. If (and it’s a big if) this translates into slower inflation, we can see the Federal Reserve starting cuts early and continuing a steady process of easing.
The first big hurdle is the inflation data due out this week. The strength of rents and the absurdly high weight placed on it in the US CPI (it accounts for 36% of the index) are a big barrier to continued disinflation but weakness in other areas might just deliver an okay number.
Meanwhile the Bank of England meets this week. They won’t cut rates but they will reduce their inflation forecast and are likely to present an optimistic outlook. It’s possible that another member joins Swati Dhingra and votes for a cut. The big factor causing hesitation is the prospect that the 10% hike in the minimum wage, which took effect last month, will lead to a broader increase in wage inflation. Yes, the three-month on three-month rate will rise but that should be a one off.
The ECB has effectively promised us a cut in June and the outlook seems clear there. They too may see a temporary blip in wage growth but the underlying trend is firmly downwards.
As we said in our last podcast, the pessimism on interest rate cuts has probably peaked and we can look forward to a more favourable background for financial markets as inflation declines, the US resumes a soft landing and the rest of the world economy picks up. I discussed all this in much more detail in my webinar, which is available on BrightTalk. If you need more info please speak to your CTI contact.
