Markets repriced after a line-ball decision between a 25 or 50bps rate cut from the Fed went the way of a more frontloaded start to the easing cycle in the US. Equities ended the week higher and the US dollar declined against most majors excluding the Yen as the Bank of Japan left rates unchanged. With the easing cycle underway, the initial move has been a steeper treasury curve led by the long end. The 2-year segment ended the week essentially flat, with the Fed's signalling of a substantial amount of policy easing ahead playing catch-up to markets.
Fed goes big to start easing cycle
A frontloaded start to the Fed's easing cycle with a 50bps rate cut to 4.75-5.0% signals the FOMC's intent to avoid falling behind the curve with a soft landing for the US economy on the line. Backed by sufficient confidence that inflation is on track to return to target, addressing rising risks to the labour market is now the focus for the FOMC. This week's decision formalised this policy pivot, communicated intially at the recent Jackson Hole Symposium. At the post-meeting press conference, Chair Powell said these were the first steps in a recalibration of monetary policy away from restrictive settings to a more neutral level for interest rates.
The nuance in the press conference revolved around Chair Powell making the case that starting the easing cycle with a larger 50bps cut instead of a conventional 25bps move did not mean alarm bells were ringing at the Fed. However, FOMC members are on the same page that a material easing cycle will be needed for a soft landing not be be derailed. The updated set of economic projections has kept the outlook for economic growth at 2% across the forecast horizon, but that is conditioned on a more aggressive easing cycle than previously anticipated. An additional 50bps of cuts is seen by year-end to 4.4%, down from 5.1% previously. This is then followed by 100bps of cuts in 2025, taking the Fed funds rate to 3.4% compared to 4.1% projected in June before rates eventually fall further in 2026 (2.9%).
This dovish reassessment of the rates outlook was in response to an uplift in forecasts for the unemployment rate, with risks seen to the upside. Unemployment is now expected to reach 4.4% later this year (from 4.0% previously) and hold at that level through 2025 (from 4.2%). Due to the cooling labour market, the inflation forecasts for both headline and core PCE prices were trimmed to 2.3% and 2.6% respectively this year and 2.1% and 2.2% in 2025, highlighting how the balance of risks has swung in the US.
BoE holds rates steady
This week's Bank of England meeting was largely a non-event for markets as rates were left unchanged at 5.0% in an 8-1 decision from the Monetary Policy Committee (MPC). Meanwhile, the MPC announced a target of £100bn for balance sheet reduction over the next 12 months, a continuation of the status quo.
After commencing its easing cycle only last month, the MPC's decision statement noted that it is taking a 'gradual approach to removing policy restraint'. Notably, there remains caution around easing too quickly given that inflation risks have not yet been contained, particularly in relation to services prices. Depending on how economic conditions and the labour market evolves, there is a range of scenarios the MPC is looking at in terms of how long restrictive rates will be required. As set out in the August Monetary Policy Report, the MPC's baseline outlook is that lower inflation will filter through to price- and wage-setting processes, allowing for rates to be reduced over the next couple of years.
Strong Australian labour market to keep the RBA on hold
Another solid update on the Australian labour market should keep the RBA quiet at next week's meeting, with rates to stay on hold around its pushback to near-term rate cuts. Employment exceeded expectations for the 5th month in succession rising by 47.5k in August (vs 26k forecast), now up by more than 300k in 2024 (reviewed here). The resilience of employment to slower economic growth helped the unemployment rate print at an unchanged 4.2% as labour force participation remained at a record high of 67.1%. Overall, the report was consistent with the RBA's view that the labour market is seeing some rebalancing but still remains strong. This will likely keep the RBA's focus on the inflation side of its mandate at next week's meeting.