Fed Policy Uncertainty as PCE Data Looms, Markets Split on Rate Cut
As markets seek further clues on the Federal Reserve's (Fed) upcoming policy path, recent data has showcased the resilience of the U.S. economy. The data has reinforced the view that the economy may continue to perform strongly without aggressive easing measures, tempering expectations for an additional half-point rate cut. All eyes are now on today’s release of the Personal Consumption Expenditures (PCE) Price Index data.
The third estimate of the U.S. Gross Domestic Product (GDP) for the second quarter of this year confirmed a 3% growth rate, consistent with previous estimates. The acceleration in GDP compared to the first quarter primarily reflects momentum in consumer spending, private inventory investments, and business expenditures.
Moreover, in the second quarter, the PCE Price Index rose by 2.5% for all items, while the core index, excluding food and energy, remained unchanged from earlier estimates at 2.8%. Additionally, real disposable personal income saw an upward revision, increasing by 1.4 percentage points to a 2.4% rise.
According to comprehensive annual revision data published by the U.S. Bureau of Economic Analysis, the U.S. economy recovered more robustly from the pandemic than previously estimated. This recovery was primarily driven by consumer-led growth, bolstered by strong incomes. Meanwhile, growth estimates for the first half of this year were revised upward from 1.4% to 1.6%. Consequently, the growth reports underscore the resilience of the U.S. economy.
On the labor market front, weekly data supported a robust outlook. Initial jobless claims fell to 218K for the week ending September 20, marking a four-month low and coming in below the previous week’s revised 222K and the market median expectation of 225K.
The lack of significant increases in claims highlights that layoffs in the U.S. are not critical. On the other hand, continuing unemployment claims rose slightly from 1.82M to 1.83M, indicating a slowdown in new hires, though the figure remains relatively low.
Some economists attribute the low level of unemployment claims to the fact that many of those laid off are either ineligible for unemployment insurance benefits or undocumented workers. Meanwhile, some companies have announced downsizing plans. Paramount Global conducted a second round of layoffs this week, and General Motors announced it would temporarily lay off two-thirds of workers at its Kansas engine plant by mid-2025.
Although current labor market data indicate that the market remains healthy, some market participants are pricing in another jumbo rate cut, with the Fed possibly avoiding further cooling of the labor market.
According to current futures market data, the market remains split. A half-point rate cut for November is priced at 50.2%, while the probability of continuing with a 25-basis point cut stands at 49.8%. Today’s PCE data could be crucial in determining which direction the balance shifts.
Fed Rate Cut Hopes Push Gold to Record Levels, But Strong U.S. Data Cools Momentum
GOLD surged to a new all-time high of $2,685 per ounce yesterday, driven by expectations of aggressive Fed rate cuts, before pulling back.
Following strong U.S. data, U.S. yields slightly recovered, weighing on GOLD’s upward momentum. Yields on 2-year U.S. Treasuries rebounded to around 3.62%, while the benchmark 10-year yields climbed to 3.79%.
The start of a rate-cutting cycle by major central banks, particularly the Fed, reduces the opportunity cost of holding gold and keeps its outlook positive. Meanwhile, ongoing geopolitical tensions in the Middle East and uncertainty surrounding the upcoming U.S. elections continue to support safe-haven demand and limit any significant downside correction. However, before making new directional bets, markets will wait for the U.S. inflation report to be released today.
Economic Contraction and Deflation Boost ECB Rate Cut Odds
This week’s data from the Eurozone revealed that the economic slowdown is becoming more pronounced. Private sector business activity contracted in the two largest economies in the region in September; while production in Germany continued to shrink, France experienced a collapse in its services sector.
The preliminary readings of September’s Purchasing Managers' Index (PMI), released on Monday, revealed that France’s services sector activity dropped from 55 to 48.3, significantly missing the market expectation of 52.7. This indicates a collapse from the expansion zone into contraction.
Meanwhile, Germany’s manufacturing sector activity continued to contract, and a slowdown was also observed in the services sector. The overall PMI data for the Eurozone indicate that the regional economy has entered contraction territory.
Earlier today, preliminary September inflation readings from France and Spain showed that monthly inflation declines exceeded expectations. The monthly figures point to deflation, while annual inflation in both countries fell to 1.5%, significantly below the ECB’s target rate.
This week’s data has strengthened expectations of a rate cut from the European Central Bank (ECB), adding pressure on the euro. After reducing the deposit facility rate by 25 basis points to 3.5% at its September meeting, market expectations are mixed regarding whether the ECB will proceed with another cut in October.
Statements from ECB officials have also fueled these mixed expectations. Governing Council member Madis Muller expressed that the risks in the region are clearly tilted to the downside. In contrast, Executive Board member Isabel Schnabel sounded more concerned about the economy in a recent presentation. On the other hand, Governing Council member Martins Kazaks emphasized that the persistent threat of services inflation currently outweighs concerns about growth.
However, officials often emphasize the need for more data before deciding on a rate cut in October. In this context, next week’s regional inflation report could be critical in shaping expectations.
RBA Holds Rates Steady, Inflation Eases Beyond Expectations
The Reserve Bank of Australia (RBA) decided to keep the cash rate at a 12-year high of 4.35%, in line with market expectations. Besides, the monthly inflation report released after the decision showed that price pressures in Australia have eased more than expected. The consumer price index, which had risen by 3.5% in the previous month, fell to 2.7%, exceeding the market’s expectation of a 2.8% increase.
In remarks following the meeting, Governor Michelle Bullock stated that, for the first time since March, interest rate hikes were off the table. Although Bullock had previously indicated that no rate cuts would be appropriate this year, her comments excluding rate hikes were interpreted as a softening of the RBA’s hawkish stance. Futures market data showed the likelihood of a rate cut in December was priced at 50-50 before the statement, but expectations have now risen to 70%.
Meanwhile, political pressure on the RBA is increasing ahead of the May elections in Australia, with the central bank being accused of prolonging the cost-of-living crisis. This factor could support expectations for a potential rate cut in December, and as these expectations persist, the Australian dollar’s momentum may remain under pressure against the U.S. dollar.
Japanese Inflation Cools, but Rate Hike Expectations Stay Firm
The Tokyo inflation report, released earlier in the day, revealed that consumer prices in September fell from 2.6% to 2.2% for all items. The core index, excluding energy and food, remained at 1.6%, while the index excluding fresh food recorded its slowest rise since May, increasing by 2%.
Government energy subsidies primarily supported the slowdown in core inflation. Therefore, as temporary factors drive this slowdown, expectations have not been altered that the Bank of Japan (BoJ) will raise interest rates in the upcoming period.
More importantly, the ruling party’s decision to choose Shigeru Ishiba, who supports BoJ’s policy normalization process, as the next leader instead of someone opposing rate hikes, bolstered rate hike expectations and led to a sharp appreciation of the Japanese yen against the U.S. dollar. As dollar/yen volatility continues, the upcoming U.S. inflation report could guide the course of market pricing.