Weekly focus – Enter Fed cutting cycle

Markets started off the week lingering at the fear of recession after the August US jobs report failed to shake off those fears. Chinese core inflation dropping further to 0.3% as a symptom of weak Chinese demand only added further to the sour risk sentiment. We saw it in FX markets, with further slides in Swedish and Norwegian kroner, the latter also weighed down by cheaper oil. Sentiment turned around a bit on Thursday, though, with equities higher and a rebound in industrial metals and oil prices.

The ECB cut rates by 25bp as widely expected. President Lagarde provided no guidance on the timing of the next policy move yet given that she did not see the need to impact the market pricing, we believe that the ECB is overall content with the current market pricing of 25bp/quarter through the end of next year, as domestic inflation pressure remains elevated due to high wage growth. Lagarde also highlighted the further confidence of the 2% inflation target being met in the medium-term, while the accompanying staff projections only saw cosmetic changes. On the data front, July industrial production data from the euro area confirmed what PMIs have already shown, namely that the manufacturing sector will weigh on Q3 GDP growth.

In the US, Kamala Harris came out of the presidential debate on top and markets reacted by sending the USD and yields slightly lower, suggesting that expectations of Trump pursuing more expansionary fiscal policies and protectionist measures remain intact. This is probably also a good gauge for how markets may react to election news going forward.

With a big question mark still hanging over the US labour market, inflation data once again took markets' focus this week on the hopes of getting some clarity on the next Fed move. 0.3% m/m core inflation was a bit more than expected, mostly driven by shelter prices. On the one hand, it is a comforting sign that businesses still see room to hike prices, and a low inflation print would have added to recession concerns. On the other hand, it forces the Fed to keep an eye on the inflation mandate and probably deprives them from the opportunity to cut rates by more than 25bp next week. Ahead of the FOMC meeting, August retail sales are released but we think the bar for changing the rate outlook is high. We see a 25bp cut as the clear base case.

We also have several other central bank meetings on the schedule next week. We expect rates unchanged at all of them. The Bank of England meeting on Thursday will be focused on the inflation data, which is released the day ahead. On Friday, inflation data released during the Bank of Japan's two-day policy meeting will probably show price pressures picking up. Even so, the bond market rally since the late July meeting and cheaper oil prices has been a boon to the yen, which makes the initial motive for hiking rates less acute. We expect the next BoJ hike in December. We will also zoom in on the final euro area inflation data, which will allow us to gauge domestic inflation. It has remained high and is a key reason we expect only a gradual cutting approach from the ECB.

Download The Full Weekly Focus