Fed poised to cut rates as markets brace for Powell’s guidance

Markets

 It’s showtime. A weak July payrolls report and Fed Chair Powell’s speech in Jackson Hole set the stage for a re-start of the Fed’s normalization cycle tonight. Powell acknowledged that risks around the Fed’s dual mandate were shifting from upward inflation risks to downward employment risks. The US labour market is some kind of optical illusion where a marked slowdown in both the supply and demand of workers keep the unemployment rate in balance. This curious equilibrium could be easily distorted if employers switch from labour hoarding to implementing job cuts. Weakness in labour demand also limits the likelihood of a virtuous price-wage spiral should US tariffs in the end have a more profound effect on prices than what currently showed in the data. Powell’s framing was less dramatic than a year ago when the Fed turned to a jumbo rate cut (50 bps). While a dissenting vote in favour of such action is possible and even likely (Waller, Miran?), the US central bank is expected to stick with a regular 25 bps rate cut to 4%-4.25%. The bigger question is whether Powell and/or the updated quarterly Summary of Economic Projections signal the start of cutting cycle (2 more 25 bps rate cuts this year). Back in June, the median estimate suggested two rate cuts during 2025. Recent comments point to quite some diverging views among FOMC members. Powell will have to walk a tight rope to keep market expectations in check. Median estimates for 2026 and 2027 will probably be closer to a neutral 3% than in June (3.5%-3.75 & 3.25%-3.5%) but the difference in opinion will be large. It’s back to navigating the stars under cloudy skies. The most uncertain, strangest and politically-influenced FOMC meeting in years makes it hard to offer guidance for the market reaction. We have the impression that US markets are willing to pick up any dovish signals tonight, adding or accelerating 2026 rate cut bets. If the tone of Powell’s presser is in line with his Jackson Hole speech, they’ll see it as an all clear. The US 2-yr and 10-yr yield (real rate suffering) are at risk of losing technical/psychologic support at respectively 3.5% and 4%. The dollar was already in dire straits earlier this week with EUR/USD yesterday closing above the 1.1829 YtD top. First 1.20+ levels since June 2021 could be in the making. Our medium-term target still stands at 1.2349 (2021 top). The trade-weighted dollar yesterday closed just above the YtD bottom (96.63 vs 96.38).

UK August inflation numbers printed in line with consensus this morning. Headline CPI accelerated to 0.3% M/M to remain steady (and sticky) at 3.8% Y/Y. Core CPI and services CPI printed at 3.6% Y/Y (from 3.8% Y/Y) and 4.7% Y/Y (from 5% Y/Y) respectively. Today’s number won’t alter the picture for the Bank of England which meets tomorrow. GBP trades unchanged after EUR/GBP yesterday followed EUR/USD’s move higher, from 0.8650 to 0.8695. 

News and views

Indonesia’s Economic Minister Hartarto confirmed to Reuters today that the EU and Indonesia have finalized a trade agreement that will be signed on September 23. Yesterday, the Financial Times already reported that the EU trade Commissioner Maros Sefcovic will travel to Indonesia to sign the agreement. The process to reach an agreement was accelerated by US President Trump’s tariff policy that affected both countries. Indonesian officials indicated that the agreement will give Indonesia zero tariffs for 80% of its exports and the removal of non-tariff barriers. At the same time, the EU will get lower tariffs for its industrial and agriculture products to the country. Bilateral trade between the two countries amounted to about $30bn last year.

Both Japanese exports (-0.1% Y/Y) and imports (-5.2% Y/Y) fell in value terms compared with August of last year. For exports it was the fourth consecutive monthly decline. Japan posted a trade deficit of JPY 242.5bn (about $1.7bn). Exports to the US declined by 13.8% compared to the same month last year as trade flows adapted to new trade tariffs imposed by the US. Exports of auto’s declined by -28.4%. The trade surplus between Japan and the US dropped to JPY 324bn, a decline of about 50% compared to the same month last year and the lowest level in one year and a half. Exports to China dropped by 0.5%. Exports to Europe rose 5.5%.

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