Fed debate leave markets in holding pattern

Markets

Markets turn somewhat more complacent over US political developments. They take a wait‐and‐see approach with Fed governor Cook yesterday suing US President Trump calling his move to fire her a power grab with potentially irreparable harm to the US economy. She also asked to preserve her current role at the Fed during the lawsuit to protect public interests. A first emergency hearing is set for today with rulings in the case coming in the next days and weeks and remaining a potential source of market stress/volatility. Fed governor Cook also suggested that an unintentional “clerical error” might have been behind the mortgage fraud allegations resulting in President Trump’s decision to fire her for cause. In absence of other strong drivers, US Treasuries corrected on the recent bull steepening with daily changes ranging between +2 bps (2‐yr) and ‐4.5 bps (30‐yr). Fed governor Waller, who dissented in July, argued again in favour of lower interest rates: “With underlying inflation close to 2%, market‐ based measures of longer‐term inflation expectations firmly anchored, and the chances of an undesirable weakening in the labor market increased, proper risk management means the FOMC should be cutting the policy rate now.” His base scenario remains a 25 bps rate cut but he wouldn’t mind opting for a jumbo move (50 bps) if next week’s August payrolls report point to a substantially weakening of the economy. Waller expects additional cuts over the next three to six months with the pace being driven by the incoming data. Last week’s dovish pivot by Fed Chair Powell put the onus on labour market data and takes the edge of today’s July PCE deflators. A significant increase in PPI data released earlier this month points to upward risks around the consensus view even as CPI inflation barely showed any signs of (tariff‐related) inflation in July. The headline number is forecast to rise by 0.2% M/M and 2.6% Y/Y while the underlying measure is pencilled at 0.3% M/M and 2.9% Y/Y. Even in case of a beat, we don’t think that US money markets will be eager to take on bets on a policy rate status quo in September. So the overall market impact might be low with the approaching long weekend (US closed on Monday for Labour Day) also arguing in favour of subdued trading. European focus turns to national inflation numbers setting the tone for the EMU reading on Monday. The ECB also releases its monthly consumer inflation expectations survey (1y & 3y). With the central bank clearly signalling the monetary policy is in a happy place, we see asymmetric risks with especially sensitivity to upward surprise (weakness at long end of the curve).  

News and views

Japanese data painted a complex economic context this morning as the BOJ is still in the process of assessing the timing of further policy normalization. Tokyo inflation (ex fresh food) as expected eased from 2.9% to 2.5%. The decline was mainly due to government subsidies easing consumer utility bills. The core measure excluding both fresh food and energy only slowed marginally from 3.1% to 3%, holding well above the BOJ’s 2% target. National July activity data mostly disappointed. Industrial production declined 1.6% M/M while only a more modest ‐1.1% was expected, amongst others due to a drop in car production. July retail sales also printed well below expectations at       ‐1.6% M/M and 0.3% Y/Y. The unemployment rate unexpectedly decline from 2.5% to 2.3%. Persistently high inflation eroding real wage growth and consumer spending, still supports a scenario of the BoJ resuming policy tightening later this year. The market sees a 50% probability of a 25 bps rate hike at the end October policy meeting. According to people familiar with the matter, the Japan Finance Ministry also asked primary dealers on their assessment with respect to the issuance of long term bonds. The Fin Min is said to consider cutting back auctions in this sector after the recent rise in long term yields.

The Polish government yesterday unveiled its 2026 budget. The budget still sees a 2026 budget deficit of 6.5% coming from an upwardly revised 6.9% deficit expected for this year. The budget assumes GDP growth of 3.5% compared to 3.4% expected for this year. The government expects a debt to GDP level of 53.8% (according to national standards) up from 48.9% this year. As such it remains below the 55% prudential standard, that could trigger important budget constraints. General debt‐to‐GDP as defined by the EU is expected to rise to 66.8% next year from 60.8% this year.

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