Markets Divided on Fed’s Next Move as Easing Path Remains Unclear
The Federal Reserve's preferred inflation gauge, the Personal Consumption Expenditures (PCE) Price Index, revealed on Friday that inflation in the U.S. rose modestly, underscoring signs of a cooling economy.
According to the U.S. Bureau of Economic Analysis report, the PCE price index increased by 0.1% month-over-month, while the annual rise decelerated from the previous 2.5% to 2.2%, falling below the market median forecast of 2.3%. Excluding volatile food and energy prices, the Core PCE Index increased by 0.1% monthly and rose to 2.7% annually from the previous 2.6%, aligning with market expectations.
The report showed that, compared to the same month last year, goods prices declined by 0.9% while services prices increased by 3.7%. Additionally, food prices rose by 1.1%, and energy prices fell by 5%. Moreover, inflation-adjusted consumer spending increased by 0.1%, nominal personal income grew by 0.2%, and the savings rate dropped to 4.8%.
In its September monetary policy meeting, the Fed updated its economic projections. For 2024, the forecast for the PCE price index for all items was revised to 2.3%, and for the core index to 2.6%. The PCE data indicate that headline inflation has softened beyond the Fed’s forecast; however, core inflation remains high due to ongoing rigidity in service prices.
The PCE data confirm that the Fed will likely continue easing in the coming period, though the extent of rate cuts remains unclear. Market participants remain divided regarding the next move. According to futures market data, a 50 basis point cut in November is priced in with a 54% probability, while a 25 basis point cut holds a 46% chance.
Slower income growth in the U.S. puts pressure on consumer spending, providing a tailwind for inflation's decline. As inflationary pressures ease, the Fed is likely to shift its focus more toward achieving its maximum employment goal. In this context, employment reports to be released this Friday could be pivotal for the Fed's next move.
As bets on larger Fed rate cuts increase, pressure on the U.S. dollar and Treasury yields is mounting. However, the latest Bloomberg Markets Live Pulse survey revealed that as global interest rates fall, risk appetite rises, prompting investors to move away from traditional safe havens like Treasuries, the dollar, and gold. The survey includes responses from 499 global portfolio managers, economists, and retail investors.
When asked which trades are best to avoid for the remainder of the year, 36% of respondents named oil, 29% mentioned Treasuries and 24% cited gold. Additionally, 60% of participants predicted that U.S. stocks would deliver the best returns in the fourth quarter, while 59% favored emerging markets, with a particular emphasis on China, when excluding U.S. The survey also indicated that interest in the U.S. dollar remains limited. Eighty percent of respondents expect the dollar to stay around current levels or end the year with a slight decline of approximately 1%.
Gold's Rally Faces Mixed Signals as Fed Rate Cut Speculation Grows
Amid mixed expectations regarding the extent of the Federal Reserve's upcoming rate cuts, U.S. Treasury yields have declined for five consecutive months, marking the longest downward streak in 14 years. This has provided a tailwind for gold, breaking records consecutively.
Hedge funds and other large speculators increased their net long positions on gold by 0.9% last week, raising bullish bets on the yellow metal. Net long positions have reached their highest level since March 2020.
While several factors continue to support a positive outlook for gold, short-term price movements are being significantly influenced by expectations of Fed rate cuts. As the Fed's expectations for gradual rate cuts increase, the upward momentum in gold could face some pressure. On the contrary, if U.S. labor data due on Friday falls below expectations, it could pave the way for a new record high in gold.
On the other hand, the global decline in interest rates is boosting risk appetite, somewhat reducing demand for safe-haven assets. Record-high gold prices also affect retail demand in China, the world’s largest gold consumer. While these factors are slowing gold’s upward momentum, rising tensions in the Middle East could keep demand for safe-haven assets robust, continuing to limit downward movements.
China Unveils Major Stimulus Package to Avert Deflation and Boost Economy
Last week, the People’s Bank of China (PBoC) announced significant stimulus measures aimed at boosting domestic demand, preventing the country from slipping into a deflationary spiral, and addressing the ongoing property crisis. The PBoC slashed its one-year policy rates by a record level, lifted many restrictions on property purchases, and introduced steps to provide mortgage refinancing worth up to $5.3 trillion to millions of households. Additionally, the Politburo announced plans to increase fiscal spending to avoid missing its economic growth targets.
Following these stimulus announcements, expectations rose that the measures could help the Chinese economy hit its growth target this year. As a result, the Chinese stock market posted its biggest weekly gain since 2008 last week.
However, concerns about the world's second-largest economy are far from over. Economists believe that considering the property market crisis, weak domestic demand, and rising global trade tensions, these measures are merely a down payment, highlighting the potential need for more stimulus in the future.
This week, markets will be closely watching the European Union’s vote on October 4th regarding tariffs of up to 45% on electric vehicles imported from China, which is a significant concern for the Chinese economy. If approved, additional taxes of up to 35% will be added to the current 10% starting in November and lasting for five years.
Such a development could lead to further losses for Chinese manufacturers, whose electric vehicle sales to Europe have already dropped by around 48% in the last two months. Consequently, with external trade uncertainties lingering, the effectiveness of these stimulus measures in boosting domestic demand will be crucial for the outlook of the Chinese economy.
Unexpected Leadership Shift Boosts Yen, but Economists Caution Limited Gains
The Japanese yen rose by approximately 1.9% on Friday following the unexpected victory of Shigeru Ishiba in the ruling Liberal Democratic Party’s leadership race.
There had been speculation that Ishiba’s opponent, Takaichi, would encourage the Bank of Japan (BoJ) to keep interest rates low. As a result, Ishiba’s surprise win boosted expectations for the BoJ to continue its policy normalization process.
On the other hand, economists note that the yen’s strong movement may reflect that Ishiba’s victory had not been priced in. They also suggest that Ishiba's post-election comments were intended to temper his hawkish image. While Ishiba respects the BoJ’s independence, he does not actively favor raising interest rates. As a result, the yen’s gains could remain limited.
RBA's Policy Path and Economic Outlook in the Spotlight
As price pressures in Australia continue to ease modestly, the Reserve Bank of Australia (RBA) kept interest rates at a 12-year high last week. While the RBA ruled out the possibility of any rate cuts this year, some market participants still expect a rate cut in December.
One of the main drivers of rate cut expectations is the challenges facing Australia's economic growth. Treasurer Jim Chalmers highlighted weak demand from China as a factor weighing on the Australian economy. However, China's recent stimulus package is expected to provide some support. On the one hand, as the interest rate gap between the RBA and the Fed narrows, positive expectations for Australia's economic outlook could support the Australian dollar's momentum against the U.S. dollar.