Bonds continued to sell off this week with solid growth and inflation data in the US and euro area combining with a poorly received UK budget to push yields higher. This saw the euro supported against broader US dollar strength, seeing the Australian dollar weaken into next week's presidential election where betting markets still lean towards a Trump victory. The overall backdrop was a headwind to equities, which softened broadly across the US, Europe and Asia.
US data this week confirmed solid economic momentum and inflation still elevated relative to target, factors that have driven the recent repricing of the Fed's easing cycle. Growth in the US economy expanded by 0.7%q/q in Q3 and 2.7% through the year, bolstered by resilient household consumption (3%Y/Y). Meanwhile, the Fed's preferred inflation gauge - the core PCE deflator - remained at 2.7%yr in September, still somewhat above the Fed's 2% target. Markets largely looked through the October payrolls report - employment rising by just 12k against a low conviction median estimate of 100k - due to the effects of hurricanes and industrial strikes. An unchanged unemployment rate of 4.1% and the employment cost index moderating from 4.1% to 3.9% year-ended in Q3 - a low since Q4 2021 - were inputs markets saw as consistent with labour market conditions continuing to rebalance from cycle tights.
Although not to the scale of the 2022 crisis, the UK budget - the first under the new government - became a market event. The details announced by Chancellor Reeves unveiled a high spend-and-tax budget, the independent Office for Budget Responsibility (OBR) estimating the new measures raise the public spend by almost £70bn a year for the next 5 years, spending that is roughly 50% funded by a range of increased taxes. Government debt will be increased to cover the shortfall, rising in the order of £32 per year across the forward projections. The combination of increased gilt issuance - pressing £300bn in 2024/25 and 2025/26 according to the DMO's post-budget remit - and the OBR's assessment that the budget raises the near-term outlook for GDP growth above potential and adds to inflationary pressures saw markets reprice on expectations for a more gradual BoE easing cycle.
In the euro area, markets were given pause to review their dovish interpretation of the ECB's reaction function. Bets for a 50bps rate cut from the ECB in December were scaled back as Q3 GDP growth and inflation estimates for October surprised to the upside, while the ECB's Schnabel pushed back on aggressive cuts. Economic activity - likely boosted by the Paris Olympics - outperformed modest expectations (0.2%) advancing 0.4% in Q3 (0.9%Y/Y), its strongest quarterly growth in 2 years. October's flash estimates reported headline inflation lifted from 1.7% to 2.0%yr while the core rate held at an unchanged 2.7%yr pace, both measures 10bps above consensus.
Markets look to have already done much of the RBA's work ahead of next week's meeting, pushing pricing for rate cuts well into 2025. While electricity rebates and declining fuel prices have revived Australia's disinflationary process - headline CPI slowed to 0.2% in Q3 lowering the annual pace from 3.8% to 2.8% - core (or trimmed mean) inflation (0.8%q/q) eased more modestly from 3.9% to 3.5% year-on-year, a pace still elevated enough to the 2-3% target band to keep the RBA hawkish to rate cut prospects in the near term. More in-depth analysis of the Q3 CPI report can be found in my review here. In other key developments in Australia this week, household demand remains subdued, though retail volumes picked up (0.5%) in Q3 (see here); dwelling approvals lifted 4.4% in September as house approvals rose to their highest level in 2 years (see here); and housing finance commitments saw their first decline in 8 months easing modestly (-0.3%) in September (see here).
