Muzinich Weekly Market Comment: Time for a super-sized rate cut?

September 2, 2024

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In our latest roundup of developments in financial markets and economies, we consider whether a softer jobs market in the US could trigger a more radical next move by the Fed.

Despite the turbulence that characterised much of August, the record books will reflect favourably on investors, particularly those in fixed income. Government bond yields fell, led by the short end, as monetary policy easing in the US was all but confirmed on August 23 at the Jackson Hole Economic Policy Symposium, when Federal Reserve Chair Jerome Powell stated: “The time has come for policy to adjust.”^[1]

The spread between 2 and 10-year US government bonds is now just -5 basis points (bps), narrowing from an inversion of -50 bps in June. Corporate credit markets benefited from falling government yields, inflows, and seasonally low supply, which caused spreads to tighten. Emerging market high-yield credit has now returned +9.6% year-to-date.^[2]

Oil prices have remained range bound as geopolitical risk and global economic activity offset each other. Meanwhile, gold reached new highs in August, a reminder that not all is balanced in the world.

Most equity markets are in positive territory, with the Hang Seng index in Hong Kong the outperformer, buoyed by speculation that the Chinese authorities could allow homeowners to refinance as much as US$5.4 trillion in mortgages to lower borrowing costs.^[3] While this could boost domestic consumption, it could come at the expense of state banks’ profitability.

In Japan, the benchmark Nikkei index was the epicentre of market volatility at the start of August. But having at one point been down 17%, it ended the month just 1% below where it started it. In Europe, Spanish equities led the way, while in the Americas, the Brazilian Ibovespa outperformed.

Data dependency

All year, central banks around the globe have emphasised that policy decisions would be data dependent. As such, updates on consumer prices released in the final week of each month have been watched closely by investors looking for clues on potential policy shifts.

After spooking markets with a surprise rate hike in late July, the Bank of Japan (BoJ) will be keen to avoid causing further storm clouds in the coming months. However, this was tested by the latest inflation data released last week, with the headline Tokyo Consumer Price Index rising 2.6% year-on-year in August, up from 2.2% in July and above consensus expectations.^[4]

A base effect from lower energy prices 12 months ago contributed to the increase, but the report also showed that a weak yen and rising labour costs are driving broad-based price gains. Speculation is rising that the BoJ may be forced to tighten policy further in October if these trends continue.

The situation is clearer in the Euro area, where inflation fell to its lowest level since mid-2021. Consumer prices rose 2.2% year-on-year in August, significantly lower than July’s 2.6% and in line with consensus. This should give the European Central Bank (ECB) the green light to make a further 25bps cut to policy rates in September. The question investors are now asking is whether the ECB will cut twice or three times this year, with the overnight interest rate swap market currently pricing in 62bps of easing.

Markets seek super-sized move by Fed

In the US, two other conclusions can be drawn from Jackson Hole conference in addition to Powell’s signalling of a cut in policy rates at the September meeting of the Federal Open Market Committee (FOMC). The first is a shift in the Fed’s priorities from keeping prices stable to promoting maximum employment, best illustrated by Powell’s statement: “We do not seek or welcome further cooling in labour market conditions.”^[5]

Increasing concerns over the jobs market may reduce the focus on the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index. Even so, the Fed will still have been encouraged by July’s data, as both headline and core inflation held steady at 2.5% and 2.6% year-on-year, respectively.^[6] On a 3-month annualised basis, core PCE, which many economists consider the most accurate reflection of the inflation trajectory, slowed to 1.7%, down from 2.1% in June. This marks the slowest price increase this year (see Charts of the week).

The second conclusion is that the door seems to have been left open for a super-sized 50bps rate cut in September, with the overnight interest rate swap market currently pricing in a 61% chance of such a move. While the Fed has telegraphed a 25bps cut, a weaker nonfarm payroll report on September 6 could prompt investors to price in a 50bps cut when the FOMC meets on September 17-18. Whatever the Fed decides, the market reaction will tell us much about investor sentiment.

Charts of the week: Are the Fed’s priorities shifting?

Figure 1: Core Personal Consumption Expenditures Index (3-month annualised, %)

Source: Bureau of Economic Analysis, PCE Index, August 30, 2024. For illustrative purposes only.

Figure 2: US unemployment rate, seasonally adjusted (%)

Source: Bureau of Labor Statistics, ‘The employment situation’, August 2, 2024. For illustrative purposes only.

Past performance is not a reliable indicator of current or future results.

[1] US Federal Reserve, ‘Review and Outlook Speech by Jerome Powell,’ August 23, 2024.
[2] ICE BofA Platform, ICE BofA High Yield US Emerging Markets Liquid Corporate Plus Index (EMHY), as of August 30, 2024.
[3] Bloomberg, ‘China mulls allowing refinancing on $5 trillion of mortgages,’ August 30, 2024.
[4] Statistics Bureau of Japan, August 30, 2024.
[5] US Federal Reserve, ‘Review and Outlook Speech by Jerome Powell,’ August 23, 2024.
[6] Bureau of Economic Analysis, PCE Index, August 30, 2024

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific companies is for illustrative purposes only and does not reflect the holdings of any specific past or current portfolio or account. The opinions expressed by Muzinich & Co. are as of August 30, 2024, and may change without notice. All data figures are from Bloomberg, as of September 2, 2024, unless otherwise stated.

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Index descriptions

EMHY - The ICE BofA High Yield US Emerging Markets Liquid Corporate Plus Index is a subset of The ICE BofA US Emerging Markets Liquid Corporate Plus Index including all securities rated BB1 or lower. The ICE BofA US Emerging Markets Liquid Corporate Plus Index tracks the performance of U.S. dollar denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

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