As inflation gradually comes under better control, the Fed has room to focus on the second pillar of its dual mandate

Markets

The US Bureau of Labor Statistics kept most of us waiting yesterday. The preliminary benchmark revision of payrolls for the year ending March 2024 finally showed the feared, significant downward revision. The actual payroll was 818,000 lower, or about 68,000/month. That lowers the average monthly net job growth over the reference period from 242,000 to 174,000, which nonetheless remains solid. From a momentum and narrative perspective, however, it reinforces fears that the Fed may be behind the curve. With inflation gradually coming under better control, the Fed has room to focus on the second pillar of its dual mandate: maximum employment. Given the tipping point in the labor market, this argues for a less restrictive monetary policy. We agree with this view, but still think that the US (money) markets are taking their rate cut bets too far this year and next. However, there is no point in fighting the strong market trends at this time. The minutes of the July FOMC meeting showed that the outcome was (unchanged) closer than expected. “Several officials noted that recent progress in inflation and the rise in the unemployment rate would have provided a plausible argument for a 25 basis point reduction in the target range at this meeting, or that they could have supported such a decision. The vast majority noted that if data continued to be roughly as expected, it would probably be appropriate to ease policy at the next meeting.” The US dollar and the front end of the US yield curve drifted further south in the wake of the releases. Interestingly, the very long end of the US curve showed signs of fatigue. The US 30-year Treasury yield was even slightly higher, with daily changes ranging from -5.4 basis points (2 years) to +1.7 basis points (30 years). EUR/USD closed at 1.1150, above the December 2023 peak of 1.1139. Finally, the greenback also closed above the day's lowest levels. Major US equity indices gained as much as 0.6% for Nasdaq. On today's US agenda are the PMIs for July. Risks are to the downside. We continue to expect yields in the US (ST) and the USD to remain near their recent lows, as the possibility of a 50 basis point rise in September cannot be ruled out ahead of the release of data in early September (ISM, payrolls). In Europe, the PMIs and in particular the Q2 wage data are an unknown. The latter risk remaining more timid, which limits the ECB's room for maneuver compared to the Fed.

News & Views

The Bank of Korea (BoK) left its key interest rate unchanged at 3.5%. Governor Rhee Chang-young hinted that the central bank may seek a rate cut at upcoming meetings. The domestic economy continues to show a divergence between slowing domestic demand and strong export growth. The BoK slightly revised up its 2024 growth forecast to 2.4% from 2.5% in May. Growth is expected to be unchanged at 2.1% in 2025. It expects inflation to maintain its underlying downturn trend. The consumer price index rose to 2.6% year-on-year in July due to higher gasoline prices, but the core inflation rate remained stable at 2.2%, and the BoK expects inflation to moderate further (2.5% from 2.6% this year, 2.1% next year). The BoK statement concludes that the central bank will carefully examine the trade-offs between policy variables such as inflation, growth and financial stability, and will consider the right timing for interest rate cuts while maintaining a tight monetary policy. Concerns about financial stability (household prices and household debt) are cause for caution and require a cautious approach.

The dispute between the Hungarian Central Bank (MNB) and the government over the balance between fighting inflation and supporting (sluggish) economic growth flared up again yesterday. Hungarian Finance Minister Nagy concluded that the MNB is too focused on inflation and believes that inflation of around 4% is low enough to start more growth-promoting policies. With economic growth only expected to be a subdued 2% this year, Nagy believes the central bank should take supportive measures, possibly including initiatives such as the previous Funding for Growth program. Comments come after the central bank recently indicated that the scope for continuing its easing cycle is narrowing (only one or two additional 25 basis point rate cuts this year; policy rate currently at 6.75%). The MNB meets next week. The dispute between the MNB and the government has often been negative for the forint, but this time the HUF is continuing its gradual recovery due to easing global financial conditions. EUR/HUF is currently trading at 292.7.

Graphics

GE 10-year return

The ECB cut interest rates by 25 basis points in June. Due to stubborn inflation (core, services), follow-up action is less obvious. Markets are nevertheless pricing in two to three more cuts in 2024 as disappointing US and unconvincing economic data from the EMU arrived and pulled the long end of the curve lower. The move accelerated during the market collapse in early August.

Yield on 10-year US Treasury bonds

The Fed paved the way for a first cut in September at its July meeting, keeping an eye on the risks to both sides of its dual mandate as the economy becomes more balanced. Money markets tend to favor a 50 basis point increase. The reversal weakened the technical picture for U.S. yields, as another round of weak economic data pushed 10-year yields below 4%.

EUR/USD

EUR/USD rose above the 1.09 resistance area as the dollar gradually lost interest rate support. Recession risks in the US and bets on quick and large (50 basis points) rate cuts trumped traditional safe-haven flows into the USD. EUR/USD 1.1139 (Dec 2023 high) is under pressure. 1.1276 (2023 high) serves as the next technical reference.

EUR/GBP

The BoE made a hawkish rate cut in August. The tightening monetary policy will continue to be gradually unwound, with the pace dictated by a broad data base. The strategy is similar to that of the ECB and balances EUR/GBP from a monetary perspective. Risk aversion has proved to be a more important driver of GBP recently, leading to a return from 0.84 to 0.86.