U.S. Labor Market Data to Steer Fed's September Rate Decision
August was a volatile month due to concerns surrounding the U.S. economy. Following a significant decline in labor market data at the beginning of August, the dollar depreciated by 1.6% throughout the month, marking the largest monthly decline this year.
However, data released in the last week of the month suggested that concerns about the U.S. economy might be unfounded. The U.S. economy continues to grow resiliently while inflation continues to cool.
Additionally, while this week's data will clarify the full extent of the labor market's condition, weekly reports indicate that the cooling may not be as deep as feared.
The positive inflation report will likely help maintain the optimistic tone the Federal Reserve (Fed) reflects at the Jackson Hole symposium. At the symposium, Chairman Powell said that it is time to lower interest rates and signaled that the easing cycle might begin at the September meeting.
On the other hand, uncertainty persists regarding how much and how quickly the Fed will ease its monetary policy. As the Fed's focus shifts towards labor market risks, this week's data could be decisive in shaping the extent of potential rate cuts.
This week, the markets will closely follow the critical nonfarm payroll report and a series of other labor market data leading up to it, gaining more insight into the current state of the U.S. labor market and the economy's health.
Economists forecast that the nonfarm payroll report, to be released on Friday, will show some improvement following the disappointing decline in July. Payroll growth is expected to increase by approximately 165K in August, and the unemployment rate is anticipated to drop to 4.2%.
However, some note that the downward preliminary revision of 818K to payroll growth for the April 2023-March 2024 period could make Fed officials less inclined to accept the initially reported payroll data at face value.
As the USD recovers from its lowest levels of the year, market participants continue to price in over a 30% chance of a 50 basis point rate cut in September. As data continues to be released throughout the week, the direction of expectations will be critical for the markets.
Rising Treasury Yields Pressure Gold as Strong U.S. Data Surfaces
U.S. Treasury yields rose following strong U.S. data, putting downward pressure on precious metals. The 2-year Treasury yields climbed from 3.86% before the data release to 3.92%, while the 10-year benchmark yields recovered from 3.84% to 3.91%.
The increase in yields raised the opportunity cost of non-yielding GOLD, leading to some selling pressure, causing it to drop below $2,500 per ounce.
However, ongoing geopolitical tensions and uncertainty surrounding the upcoming U.S. elections may limit GOLD's downward momentum.
Eurozone Inflation Cools Faster Than Expected, ECB Rate Cuts Likely
Last week's data from the Eurozone showed that price pressures in the region are slowing faster than expected.
In Germany, the region's largest economy, preliminary consumer price readings fell by 0.1% month-on-month in August, while annual growth of 1.9% fell short of the expected 2.1% increase. Additionally, data from France and Spain also indicated a sharp slowdown.
Across the entire region, the preliminary readings of August inflation showed an annual increase of 2.2%, marking a significant easing from the 2.6% rise in the previous month and reaching the lowest level since July 2021. Core inflation, meanwhile, saw a 2.8% increase following the previous 2.9%.
The fact that inflation in the region is moving closer to the European Central Bank’s (ECB) 2% target has strengthened expectations for another rate cut at the bank’s September 12 meeting. Markets are now anticipating two or three more cuts from the ECB this year.
While some ECB policymakers have recently supported rate cuts, bolstering market expectations, others remain cautious, warning that the fight against inflation is not yet over.
One of the statements in favor of rate cuts came from French central-bank chief Francois Villeroy de Galhau. Villeroy expressed that action should be taken at the September meeting, and that another rate cut would be fair and prudent.
On the other hand, Executive Board member Isabel Schnabel highlighted that while the data has increased confidence in the path towards the inflation target, service inflation remains high. Similarly, Governing Council member Joachim Nagel warned that the ongoing rise in service costs could potentially lead to a resurgence in inflation.
Consequently, ECB policymakers are likely to focus more on service inflation, but this is not expected to prevent a 25 basis point rate cut in September; rather, it may influence the pace of the cuts.
Indeed, policymakers who are cautious about easing have emphasized that the ECB should refrain from cutting rates too quickly, noting that the pace of easing will not be mechanical and should be data-driven.
Hawkish BoJ and Expected Fed Cuts Boost Yen Outlook for Year-End
Warnings of further weakness for the Japanese yen, which has lost approximately 12% against the U.S. dollar since the beginning of the year, have reversed.
As the Bank of Japan (BoJ) shifts towards a more hawkish stance and expected rate cuts from the Fed come into play, the interest rate differential between the U.S. and Japan is expected to narrow. These expectations have led to significant unwinding of carry trades that had pressured the yen to its lowest levels in 38 years.
Yen observers now forecast that the currency will retain its recent gains and will likely achieve further appreciation for the remainder of the year. Many financial institutions have revised their year-end dollar-yen forecasts to below the 140.000 level.
The main development driving this forecast change is Fed Chairman Jerome Powell’s indication at the Jackson Hole symposium of a commitment to rate cuts. Therefore, U.S. economic data and the Fed’s decisions on rate cuts would be crucial for the yen's future movements.
On the other hand, while market expectations are divided regarding the timing of the BoJ’s next rate hike, there is a consensus that it will happen, which continues to support the yen.
China's Economy Struggles Amid Real Estate Crisis and Manufacturing Woes
While China's ongoing real estate crisis continues to slow the economy, other sectors are also stumbling. As trade tensions with the U.S. and Europe intensify, headwinds in the manufacturing sector are growing.
Although the Caixin manufacturing purchasing managers index (PMI), which signaled contraction in July by falling to 49.8, recovered to 50.4 in August, warning signs persist. The headline figure in the PMI report showed some recovery, but it also revealed that the cost of production materials had fallen to a five-month low, and manufacturers had reduced their sales prices.
Several steps taken by the government to stimulate domestic demand are not enough to overcome the downturn, and economists continue to call for more stimulus. They argue that further fiscal easing is necessary for China to achieve its annual growth target of 5%.