- We think there is room for rate cut as inflation and jobs momentum is on track to fade.
- Stickiness of inflation in recent months could fade on the back of easing energy and rental costs.
- Parts of the jobs market are showing early signs of cooling, but overall trend is still positive.
- There is a 25% chance, in our view, that inflation and jobs momentum doesn’t ease.
- Then expect considerable bond and currency volatility as pricing would shift toward no rate cuts.
Commentary: A year without rate cuts?
Global fixed income markets swung from despair to hope in the span of three days last week. At the middle of the week, following the April 30-May 1 meetings of the Federal Open Market Committee, the markets were chastened. Comments from Chair Powell that there has lately been “a lack of further progress” towards the 2% inflation target, pushed fixed income markets to pricing in no more than one rate cut this year. By the end of the week though, a weaker than expected nonfarm payrolls release for April and an uptick in the unemployment rate brought back two rate cuts to the price.
Like the US Federal Reserve, markets are set for several months of wait and see. The key issue is the noise associated with inflation. Goods inflation has eased substantially, but some aspects of core inflation have become a source of concern. If energy and food prices remain steady, as we expect they would, a path toward additional, sustainable disinflation is there for 2Q24, but to paraphrase Chair Powell, confidence in that path has waned somewhat.
The other issue is the labour market, but we don’t see a great deal of noise there. The red-hot jobs market of 2022/23 may be behind, and some weakness has crept up in some segments (construction and retail), but overall market dynamics are still positive. The April payrolls figures that pleased the markets on Friday largely reflect a slowdown in government hiring, which in our view does not reflect a dawning of a new trend. With no fiscal tightening measure in the pipeline and outlays from recent years’ large infrastructure bills still percolating through the economy, public sector hiring is not about the fade.
How do the inflation and labour market developments align with two rate cuts in 2H24? So far, quite well, in our view. A little bit of disinflation in oil (already underway) and rentals (downtrend has emerged) will help restore the Fed’s confidence about inflation heading toward 2%, which could be further supported by marginal softening of jobs demand in the coming months.
But there is an emerging scenario under which energy and rental costs don’t ease much, and neither does the labour market. Between Middle-East tensions and Washington’s sustained fiscal support for the US economy, the idea of very little disinflation and no further weakening of the jobs market is hardly outlandish. We will assign this scenario a probability of 25%. Under this scenario, the Fed will remain on wait-and-watch for the rest of the year, eager but incapable of implementing rate cuts. We see considerable bond and currency market volatility in this scenario, a preview of which was amply visible in the last week of April. Could be a bumpy ride.
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