Rob Hogg: Out-sized rate cut in the US and rate-cut resistance from the RBA

United States   |   Europe   |   China   |   Australia   |   Outlook

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During September, most global interest rate markets exhibited a sharp “bull-steepening”. This occurs when interest rates decline across the yield curve, and shorter-term rates decline more than longer-term rates, i.e. the yield curve lowers and “steepens”. The US Federal Reserve’s mid-month 0.5% official interest rate cut was key in driving this pattern of performance, but so were the rising expectations of further rate cuts in Europe. In contrast, the Reserve Bank of Australia’s continued resistance to rate cuts (given Australia’s inflation dynamics) meant the Australian yield curve was little changed over the month.

The US 10-year yield fell by around 0.13% over the month, while the US 2-year yield fell by around 0.28% (“bull-steepening”).id

In contrast, the Australian 10-year yield rose by 0.005% while the 2-year yield slipped just 0.029%.

Early month weakness in equity markets gave way to recoveries as the month progressed, helped in part by increasing rate cut expectations. Additionally, toward the end of the month Chinese authorities announced a range of stimulus measure which drove the mainland Chinese and Hong Kong equity markets higher (by 21% and 17.5% respectively) and assisted in further progressing the global yield curve bull-steepening move.

The Australian dollar was a key beneficiary of both the announced Chinese measures and the RBA’s rate intransigence, rallying from around USD 0.6765 at the end of August to around USD 0.6910 at the end of September.

In this monthly update, we look at:

• The early month market volatility
• The US Central Bank Chair’s signal of the near certainty of a US rate cut in September
• Australian economic conditions – which may soon give the RBA reason to ease policy rates
• The Australian August listed company reporting season.

Key market movements over the month of September

 

| United States

The US Federal Reserve cuts rates by 0.5% – employment outlook key to further moves

Noting that there’s been progress made “on inflation and the balance of risks”, the Fed’s policy-making committee decided to lower the target range for the key federal funds rate by 0.5% (to a range of 4.75% to 5%) on September 18.

Interestingly, in making this initial out-sized rate cut, the Fed noted “that economic activity has continued to expand at a solid pace”. As well, in what was cautionary for those investors expecting a string of rate cuts, the Fed also noted that “inflation has made further progress toward the Committee’s 2% objective but remains somewhat elevated.”

So why did the Fed cut rates by 0.5%, given their comments above? It seems that the rationale for the larger-than-usual cut was the Fed’s shift in focus from inflation risks to employment risks in light of the recent softening in US labour market data (“job gains have slowed, and the unemployment rate has moved up”).

In his press conference, Fed Chair Powell argued that the logic for the larger cut was clear “both from an economic standpoint and also from a risk management standpoint.”

In particular, he highlighted recent downward revisions to recently recorded payroll growth.

In coming months, the FOMC will be “making decisions meeting by meeting based on the incoming data” with the most important upcoming data likely to be the next two employment reports.

What dynamics drive equity market performances during rate cutting cycles

S&P 500 total return performance indexed to the start of Fed cutting cycle (data since 1955)

 

 

US consumer confidence falls sharply in September on weakening sentiment about employment

With the US Fed now focussed primarily on the labour market, market attention has now turned more fully to examining updates about the state of the US employment situation.

The US Conference Board’s Consumer Confidence survey contains several readings related to the US jobs market, but in the most recent survey, “consumers were … more pessimistic about future labour market conditions.”

US Consumer Confidence

Index 1985=100, Shaded areas represent periods of recession

 

In particular, the Conference Board noted that

“the deterioration across the [consumer confidence] Index’s main components likely reflected consumers’ concerns about the labour market and reactions to fewer hours, slower payroll increases, [and] fewer job openings…”.

Asked directly about their views in September:

• 30.9% of consumers said jobs were “plentiful,” down from 32.7% in August.
• 18.3% of consumers said jobs were “hard to get,” up from 16.8%.

US Mortgage refinancing activity accelerating as long-term interest rates fall

One feature of the US economy that will likely cushion the extent of the coming slowdown will be the nature of mortgage refinancing.

In the US, most mortgages are fixed rate and, when these fixed mortgage rates (usually 30 years) begin to fall (as market yields fall), many homeowners take advantage of this dynamic to refinance their mortgage at a lower interest rate, so freeing-up additional disposable income.

This process has accelerated in recent weeks as 30-year bond yields have begun falling (as can be seen in the chart below).

MBA Mortgage Refinance Index

(September 22, 2023 – September 20, 2024)

 

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| Europe

Comparison between Eurozone and US activity – Eurozone activity seems to be slowing more sharply than the US

Even as the US economy is slowing, there is increasing evidence that the continental Europe an economy is slowing even more rapidly than the US. S&P Global produce a monthly series surveying conditions in the manufacturing and services sectors of a number of global economies, and that survey enables a comparison to be made between economic regions.

The survey for September revealed that while conditions in both the US and Eurozone softened further in September, conditions appear far weaker in the Eurozone.

In the Eurozone,

“September saw a renewed decline in business activity… in fact, new business decreased at the sharpest pace since January”.

This and other similar weak surveys have caused investors to expect a faster pace of European Central Bank rate cuts, which contributed to the “bull-steepening” witnessed in global yield curves during the month.

Eurozone Composite Flash PMI Output Index

By comparison, using the same survey, while the situation in the US is also softening, it remains far more robust than Europe, with S&P noting

“US business activity growth remained robust in September… signalling a sustained economic expansion over the third quarter. Only a small loss of momentum was evident in September…”

S&P Global Flash US PMI

 

 

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| Australia

Australian data suggests the RBA is inching closer to a rate cut in the coming months.

RBA policy meeting outcome – no rate cut, but no consideration of a rate rise either

In what was no surprise, the RBA monetary policy board decided to leave the cash rate target unchanged at 4.35% at its September 24 meeting and noted again that monetary

“policy will need to be sufficiently restrictive until the Board is confident that inflation is moving sustainably towards the target range”.

Following the Board’s meetings, the RBA Governor, Michele Bullock, has started doing regular press conferences. Perhaps most important of all the questions and answers at the press conference following September’s meeting was the Governor’s response to a question about whether an interest rate increase had been considered at the meeting, to which she replied, “We didn’t explicitly consider an interest rate increase at this meeting…”

This is as extremely important shift as it suggests the RBA is no longer considering a rate increase (which it had been at several prior meetings), and likely marks the beginning of rate cut-focussed deliberations in coming meetings, and an eventual reduction in the official cash rate in the next few months.

August Consumer Price Index reveals inflation is back within the RBA’s 2%-3% band

Annual inflation decelerated to 2.7% in August, down from 3.5% in July. This was the lowest reading for annual inflation in Australia since August 2021.

Significant moderators of annual inflation in August were falls in automotive fuel (lower petrol prices) and electricity (reflecting the combined impact of Commonwealth Energy Bill Relief Fund rebates and State Government rebates in Queensland, Western Australia and Tasmania).

Although these two spending categories made an out-sized (negative) contribution to the August outcome, in fact, all key underlying measures of inflation decelerated further in the month, and these measures are now rising at their slowest pace in 2½ years:

• CPI inflation (excluding volatile items and holiday travel) was 3.0% in August, down from 3.7% in July.
• Annual Trimmed Mean inflation (which excludes the falls in Automotive fuel and Electricity) was 3.4% in August, down from 3.8% in July.

Annual movement (%) in key CPI metrics

Narrowing the “breadth” of inflation pressures

Another methodology for examining the CPI is to examine the “breadth” of inflation pressures by analysing the distribution of price growth. The chart below (from CBA) shows the broad-based easing in inflation pressures in recent months, as exhibited by a declining proportion of items in the CPI basket rising by more than 3% and an increasing proportion rising by less than 2%.

Monthly CPI indicator (% of items in the basket)

Together, these “underlying” and “breadth” measures of the CPI suggest that inflation pressures are continuing to ease but are still not quite at a level that the RBA feels able to match with a rate cut. But this point is likely only a few months away and could occur this year.

Employment growth still resilient

One of the aspects of the Australian economy that has kept the RBA on the rate cutting sidelines has been the ongoing resiliency of employment, albeit mainly driven by public sector employment growth. The most recent report for August continued to highlight that resiliency as the number of unemployed people fell by around 10,000 while the number of employed people grew by around 47,000. This resulted in the unemployment rate remaining steady at 4.2 per cent and the participation rate remaining at its record high of 67.1 per cent.

Key elements within the release (employment and participation measures) show that there are still large numbers of people entering the labour force and finding work, as employers continue to look to fill a more than usual number of job vacancies. This suggests that the labour market remains relatively tight, keeping the RBA cautious about reducing monetary restraint.

Unemployment rate (%)

Employment data is suggestive of some easing in labour market conditions – although employment growth itself is still robust (albeit underpinned by solid public sector job growth rather than private sector job growth), the unemployment rate is rising (which should cool wage pressure).

The July labour market release revealed that while employment rose by another 58,200, the unemployment rate moved up to 4.2% (and is now up 0.5% points from July 2023).

 

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Read Rob’s previous macro updates  |   Watch Rob Hogg’s most recent video update  |   Back to the top of the page

 

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