Markets extended their rally this week as the Fed stepped up its intent to start dialling back restrictive monetary policy settings to lock in a soft land for the US economy. The US yield curve bull steepened, with the 2-year segment falling well below the 4% mark it has been anchored around over recent weeks. US dollar weakness remains broad based, the dollar index (DXY) now down by 3.5% over the past month. In other developments this week, Sweden's Riksbank cut rates by 25bps to 3.5%.
Fed Chair Powell's landmark speech at the Jackson Hole Symposium has set the stage for the easing cycle in the US, starting at the September meeting. A 50bps rate cut looks to be back on the table, with markets repricing the terminal rate to around 3% by the end of next year, implying around 225bps of easing through the cycle. Chair Powell effectively formalised the hand-off in the policy focus from the inflation side of the dual mandate to maintaining full employment. The key insights were that the labour market had cooled to a point where it would not be a source of inflationary pressure, and that any further loosening of conditions was not sought nor welcome. With the Fed's more than 3-year battle with inflation just about behind it, Chair Powell declared that it was now time 'for policy to adjust' by removing restrictive settings. Although growth remained solid, the Fed was witnessing an 'evolving situation' with the incoming data suggesting upside risks to inflation had faded but downside risks to employment had risen.
With the ECB's summer break drawing to a close, attention is turning towards the upcoming meeting on 12 September. Markets anticipate a rate cut at that meeting followed by another 1 or 2 more cuts before year-end. With the ECB on recess, insights have been thin recently, though the account of the July meeting was published this week. After starting its easing cycle the month before, the Governing Council held rates steady in July, with the account painting a cautious tone in a way that avoided sending too many policy signals. The main uncertainty highlighted was the evolution of wages, profits, productivity and services prices, inputs the ECB will receive updates on ahead of the September meeting that will factor into its assessment of the inflation outlook. The data received this week was supportive of a September cut as the ECB's tracker of negotiated wage growth slowed from a 4.7% pace to 3.6%Y/Y in Q2. On the activity front, August's preliminary PMI reading was consistent with modest economic growth at a 51.2 reading, up from 50.2 previously. This uplift was driven by the boost from the Paris Olympics, with services activity showing a sharper acceleration (53.3 from 51.9).
The minutes of the RBA's August meeting reinforced the post-meeting narrative of the Board pushing back market pricing for rate cuts. According to the minutes, the discussion around the board table was that the slow pace of disinflation and the new assumption baked into the RBA's forecasts that the economy is operating with a larger degree of excess demand than previously assessed meant that a tighter policy path was required than priced by markets 'in order to bring inflation sustainably back to target within a reasonable timeframe'. But that is not a decisive win for the hawks, with the minutes later pointing out that by holding rates steady against dovish pricing, financial conditions would tighten by a 'comparable degree' to a hike in the cash rate.
