The US exceptionalism theme remains the driving factor across markets, sending equities to new highs and further strengthening the dollar. With a soft landing in the US on track, markets are beginning to question whether the Fed needs to cut rates at both of its two remaining meetings this year. By contrast, the latest cut by the ECB was interpreted as dovish and inflation data in the UK may support a faster easing cycle from the BoE.
The recent easing in Fed rate cut expectations received further validation this week as September retail sales came in stronger than expected. Headline sales lifted by 0.4%m/m (vs 0.3%) but a more significant beat came from the control group - a better gauge of the momentum of household spending - at 0.7%m/m (vs 0.3%). These signals of a resilient US consumer follow the very strong nonfarm payrolls print for September (254k), which saw the unemployment rate easing to 4.1%. The Atlanta Fed's GDP tracker estimates US economic growth to be running at an annual rate of 3.4% in Q3, up from its previous estimate of 3.2%.
Declining inflation and signs of weakening activity led the ECB to cut rates for the third time this cycle, lowering the deposit rate by 25bps to 3.5%. This marks back-to-back cuts from the ECB after a quarterly interval spaced the first two reductions in June and September, both 25bps cuts. The statement from the Governing Council noted that 'the disinflationary process is well on track' while 'recent downside surprises in indicators of economic activity' had affected the inflation outlook. Accordingly, inflation is now expected to return to the 2% target 'in the course of next year' from 'over the second half of next year' in the September statement.
Overall, markets sensed a more dovish tone from the ECB at this week's meeting. Sources articles from Reuters would later report that another rate cut in December is likely and that some ECB governors were in favour of removing the pledge in the statement to keeping monetary policy 'sufficiently restrictive for as long as necessary'. Much of the focus in the post-meeting press conference was around whether the ECB needed to do more with risks to the growth outlook remaining 'titled to the downside'. President Lagarde said a fuller assessment of the situation would take place at the December meeting but at this stage the Governing Council does not foresee a recession on the horizon. The swaps market is priced for rate cuts to continue through to the first half of next year, taking the deposit rate to 2% by June.
As recently flagged by Governor Bailey, a notable slowing in UK inflation reported this week could open the door to a more aggressive approach to easing from the BoE. Headline CPI (12-month) softened from 2.2% to 1.7% in September (vs 1.9%) while the core rate was in from 3.6% to 3.2% (vs 3.4%), both at lows back to 2021. Importantly, services inflation - the basket most closely watched by the BoE - declined from 5.6% to 4.9%, its slowest since mid-2022.
A hot Australian employment report for September reaffirmed the strength of the domestic labour market and - barring a downside surprise in the upcoming Q3 inflation report on October 30 - likely delays the start of RBA rate cuts further into 2025. Employment surprised to the upside of expectations for the 6th month in a row surging by 64.1k in September, its strongest rise since February. This saw the unemployment rate hold at 4.1% from a downwardly revised 4.2% in August, as the participation rate lifted to a new cycle high of 67.2%. For more detailed analysis, please see my review of the report here.
