Weekly focus – A cut in the dark

The US government remains in shutdown and hence, we continue to have very little data on the state of the economy. Nevertheless, there is a widespread expectation, which we share, that the Fed will deliver a rate cut next week. In the absence of new information, the Fed will emphasise the weak job growth in August which has not been contradicted by the indicators that we do have about developments since. We will receive a much-delayed inflation number for September as well as PMI data for October today (after the time of writing), which could of course influence the decision, but we think the bar is high for the Fed to change its mind on the rate cut. Lowering the Fed Funds target to 4% will still mean that monetary policy is restrictive. The Fed might discuss slowing or ending the reduction of its bond holdings, not least given recent volatility in the repo market. It could also be interesting to hear how the Fed sees the situation for US regional banks.

The ECB will also deliver a rate decision in the coming week, and we see no reason to expect a different message than the "we're in a good place" in terms of interest rates and the economy that ECB president Christine Largarde highlighted at the September meeting. Since then, we have seen an increase in headline inflation to 2.2% y/y, but that is driven by base effects and should not affect the outlook. Inflation is expected to head down as wage growth slows and as a consequence of the stronger EUR. October PMI data for the euro area was stronger than expected driven by the German service sector, and markets are pricing only a small probability of a rate cut over the coming year, which we think that Lagarde is unlikely to push against.

Even as the ECB is finalising its monetary policy statement on Thursday, we will get data on GDP growth in Q3 and inflation in Germany and Spain in October, before the total euro area number Friday. On GDP, we estimate growth of 0.1% q/q as in Q2, after the strong Q1 driven not least by export to the US ahead of the tariff hikes. However, the October PMIs show a promising start to Q4 in terms of growth. On inflation, we expect it to slow to 2.1% y/y with a chance that it could be lower, and we also forecast core inflation to decline from 2.4% to 2.3%.

Trade tensions between China and the US have increased in recent weeks, with China increasing export controls on rare earth minerals and Donald Trump threatening 100% tariff on imports from China from 1 November. The US and Chinese presidents are set to meet next week, and we see a good chance that they can reach a deal. If they do not, there could be a risk-off market reaction. China outlined its next five-year plan this week and re-emphasised the need to boost domestic consumer spending but did not provide a concrete target or new means to reach that.

In Japan, Sanae Takaichi has formed a minority government that is likely to push for easing of fiscal policy, although it is not clear how much it can achieve. Takaichi is opposed to tightening of monetary policy which is one reason why we expect the Bank of Japan to keep rates unchanged at is meeting Thursday despite inflation rising in September and having exceeded the target for 42 months now.

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