Week ahead
Summer is around the corner but markets are no place for holidays, with a data-heavy economic calendar already lined up for next week.
All eyes will be on next week’s US Federal Reserve meeting as markets price in impending rate cuts after escalating trade tensions and disappointing US jobs market data, despite the economy remaining in good shape. Investors will also gauge the health of the US housing market following weak home purchases in April.
In the eurozone, the focus will be on economic sentiment readings and consumer confidence for June after markets turned more pessimistic on the back of heightened protectionism fears. Meanwhile, the Harmonised Indices of Consumer Prices inflation for May should remain low amid softer domestic conditions.
The Markit flash purchasing managers’ index (PMI) for both the eurozone and US will indicate the resilience of business activity in the two regions. The PMIs previously recorded a decline in manufacturing, while services largely held up.
UK inflation readings will be in the spotlight with more evidence of a tight labour market, after average weekly wages expanded more than expected in the three months to April. The Bank of England will monitor this data closely ahead of its policy meeting next week, with the central bank likely to reiterate its recent hawkish tone despite Brexit uncertainty.
Chart of the Week
Rate markets imply a US recession
Intensifying trade tensions and signs that the global economy has peaked, led to increased expectations that the US Federal Reserve (Fed) will cut rates very soon to prevent a severe downturn in the US economy. Recent commentary from Fed members suggests that the Fed now sympathises with these preventive steps while the rate market already seems to be three steps ahead.
Fed fund futures, which allow investors to hedge themselves against future rate moves, are pricing in a target rate of approximately 50 basis points (bps) lower by the end of December and approximately 75bps lower by the middle of next year – essentially two to three cuts. Just a week ago the market was priced for three to four cuts. This would imply that the Fed will enter into a cycle of cuts without economic data pointing to a recession.
Trade tensions have the potential to dampen the economic growth. But, cutting rates by 75 or even 100 bps at an early stage, and simply on the back of trade tensions, may lead to another policy error should the economy stay stable longer than the market believes. That said, the Fed should be concerned about inflation and inflation expectations. The target rate of 2% currently seems at risk of being breached, which would support for a rate cut itself. A discussion about what a neutral inflation point is in the future is another one to have certainly.
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