Transcript 

Looking through the gyrations of earlier this month, markets are now pricing in more cuts over the next year or so in the US, UK, eurozone (and elsewhere) than they were in the summer. Despite the commonality of the moves, these three economies are moving quite differently. We take a look at the outlook and draw conclusions about whether market pricing is correct.

Let’s start with the US. The economy here is gently slowing, inflation seems to have resumed its downward trend and following the weak labour market report earlier this month, everyone is on recession alert. We explained in our podcast two weeks ago that the chances of a recession in the near term were low – despite the strong signal in the data – and the market has now come round to that view too. Nonetheless, the mood music has changed.

There is another employment report before the FOMC meet on 18^th September and that will determine whether they cut by 25 or 50 bps. Markets expect the Fed funds rate to fall to 3.2% next year, a reasonable assumption but one with significant downside if the economy were to slow a little faster. The November election will be influential, with rates generally expected to be higher under Trump than Harris.

The UK economy by contrast is picking up and consensus expectations are for 2%  year-on-year growth by year end. That’s the fastest in the G10 (which actually has 11 members!). Now 2% is hardly booming but it does reduce the pressure on the Bank of England (BoE) to cut interest rates. Last week’s inflation numbers did come in lower than expected, including on the measure favoured by the BoE which focusses on services. But that was due to holiday prices being measured before the school holidays began so we should see a bounce back in next month’s figures.

Headline inflation is headed higher due to increases in household energy bills. On the good news side, wage inflation should see a significant fall on the closely watched three month-on-three month basis, as we move away from April’s 10% hike in the minimum wage. We discussed in last week’s podcast that government generosity on public sector pay risked boosting the ‘going rate’. I confess that I got it wrong on next year’s minimum wage though: I read ministerial comments to suggest that it would go up by 6% or more but the remit has published and the best guess is for a 4% rise. That’s good news for inflation.

The markets are pricing in 50 bps of cuts by year end with another 100bps in 2025. 5-year swap rates are now below 4% and mortgage rates for the best credits have followed suit. My guess is that we’ll get the 50 bps by year end but that the markets are too optimistic for 2025.

In the eurozone, markets expect over 50 bps by year end with another 80 bps in 2025. Eurozone growth is anaemic and inflation has fallen fast. But core inflation has been stuck at around 3% for the last three months and the European Central Bank (ECB) has been raising its inflation forecast. Much will depend on wage data released on Thursday. We only get these numbers once a quarter, the last ones were surprisingly high and the ECB went out of its way to downplay them. We need to see a big improvement this week. On balance, I’d be marginally negative on eurozone rates.

So, to sum up, the outlook for rate cuts looks reasonably good in the US, is OK near term for the UK but not in 2025 and is slightly worrying for the eurozone. All of this is data dependent of course with the next US employment report especially important.

As for risk assets, continued economic growth with falling rates looks like a favourable background to me.