Weak US Labour Report Triggers Market Overreaction to Potential Rate Cuts

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Eurozone Market Update

Eurozone inflation eased to 2.2% in August, the lowest in three years, down from 2.6% in July. Core inflation dipped to 2.8%, influenced by weaker energy prices, while services inflation rose to 4.2%, raising concerns for the ECB. Germany’s harmonised inflation fell to 2.0%, France’s to 2.2%, and Spain’s to 2.4%, boosting investor confidence in further ECB rate cuts. ECB officials discussed potential rate moves, with Governor Klaas Knot emphasising the need for more data before deciding on a September cut. The euro area’s flash composite Purchasing Managers’ Index (PMI) entered expansionary territory at 51.2. On a sector level, services PMI rose to 53.3 from 51.9, but manufacturing PMI was still dragging at 45.8. France’s composite PMI jumped 3.6 to 52.7, with services PMI up to 55.0, a two-year high following the Olympics boost. However, there is still a significant drag in Germany, which recorded a composite PMI of 48.5.

_{Source: Bloomberg, data as of 30 August 2024}

UK Market Update

Annual UK headline inflation rose to 2.2% in July, while core inflation fell to 3.3%. Services inflation unexpectedly dropped to 5.2%, raising to 42% the probability of a 25 bps rate cut at the BoE’s September meeting. However, we still expect the next cut to be in November, as the subsequent inflation and labour prints fall before the September meeting. The labour market showed resilience, with unemployment down to 4.2% and wage growth slowing to 5.4%. GDP grew by 0.6%, while PMI figures for August indicated stronger-than-expected growth. This more robust growth, coupled with the rise in private sector output and the fast pace of employment growth, could concern the more hawkish members of the BoE, who have highlighted the upside risk of inflation if growth remains strong, making a case for a pause at the next monetary policy meeting.

_{Source: Bloomberg, data as of 30 August 2024}

US Market Update

The US labour market was perceived as weak in July, with non-farm payrolls increasing by just 114,000 and private payrolls rising by 97,000, both well below expectations. The unemployment rate edged up to 4.3% from 4.1%, driven by an increase in the participation rate. Despite Fed Chair Jerome Powell explicitly pushing back on the notion of a 50 bps rate cut, the disappointing job figures fuelled speculation that the Fed may have to cut rates at all remaining meetings this year and consider a 50 bps cut if the data continues to weaken (see Chart of the Month). Meanwhile, annual inflation slowed to 2.9% in July, and core inflation dropped to 3.2%, the lowest since 2021. Second-quarter GDP surprised with a 3.0% annualised growth rate, exceeding the 2.8% forecast.

_{Source: Bloomberg, data as of 30 August 2024}

Looking Ahead

After the Fed’s July meeting emphasised labour data in future policy decisions, August’s weaker-than-expected jobs report prompted markets to drastically revise their expectations. Market participants swiftly shifted from a soft landing narrative to predicting a severe recession, with some forecasting multiple 50 bps rate cuts by the Fed. We believe the market overreacted; the labour data was not as weak as perceived. While we agree the Fed will cut rates in September, the overall economic picture does not justify cutting in larger increments. Our projections for the BoE, ECB, and Federal Open Market Committee are close to market expectations, but we reject the notion of an aggressive, front-loaded easing cycle. While economic data could deteriorate sharply, justifying more aggressive cuts, this is a low-probability scenario. Paying close attention to the broader array of economic data and its momentum is vital in the coming months for any changes to these outlooks.

Chart of the Month

_{Source: Bloomberg as of 30 August 2024}

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