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Markets and macro insights with Sebastian Orsi, CFA, Senior Research Analyst
As expected, the US Federal Reserve (Fed) moved to ease policy rates last week. Before we focus on the Fed, what other economic releases helped set the market backdrop?
- Looking at the US, retail sales data was better than expected, up 0.1% month-on-month, and the control group sales were up 0.3%. So, there are no big signals that the US consumer is falling off a cliff.
- US industrial production was also higher than anticipated, up 0.8% month-on-month, and manufacturing was up by just less than 1.0%. So, the hard data is somewhat better than the survey data as we had some manufacturing PMI weakness recently.
- In Europe, industrial production remains weak, down 0.3% month-on-month, and down about 2.2% year-on-year. Legacy industries are struggling. Elsewhere, China’s industrial production was up 4.5% year-on-year, which is slower growth and down sequentially. That’s important because it’s an end market for a lot of European industrial product exports.
- European inflation came in at 2.2% for August CPI, in line with the earlier flash estimate.
- Overall, the US economy is currently expanding in the 2.5%-3% range in real terms, which is probably about the trend growth rate, maybe a little bit above. Europe is bumping along the bottom, and China is relatively soft.
Going back to the Fed, how did markets react to the first interest rate cut since the post-pandemic surge in inflation – and what does the Fed’s rate cut cycle mean for equity markets?
- It was a positive week for global equities, up about 0.8% in the end, mainly after the Fed cut the fed funds target rate by 0.5%. The Fed also updated its economic projections (inflation expectations were tweaked lower, the unemployment rate higher due to labour supply), which outlined expectations to continue cutting rates to about 3%. Fed chair Jerome Powell indicated that the Fed could move faster or slower depending on incoming data, but the policy stance has changed to easing.
- After some initial gyrations following the widely anticipated cut, equities moved up to new all-time highs, led by the US. Cyclical sectors and large cap tech stocks led the market, while defensives were mostly down for the week. US and European bond yields were slightly higher on the week.
- Focusing on what the Fed easing cycle means for the equity markets, strategists are looking at historic precedents of Fed cuts and yield curve disinversions to gauge the probability of recession; the market going up or down; and to figure out likely relative winners and losers.
- In our view, we have a constructive backdrop for equities. Put simply, stocks typically go up when earnings go up, and earnings tend to go up when nominal GDP is growing. The current consensus outlook is for trend economic growth and solid earnings growth while valuations look fair, in aggregate. Lots of things could change but the change in Fed policy stance reduces some near-term downside risk.
- That’s a positive backdrop for equities, albeit one that’s advanced somewhat, and as we have seen recently, potentially prone to growth scares, so some caution is warranted. And, as we saw when rates rose sharply, the US economy may be less sensitive to policy rates than it was in the past, so the relative winners and losers may differ from prior cycles.
- Of course, the Fed’s change in policy stance was also well flagged, so markets will have front run some of the moves, but overall, we think the trend is likely to be higher.
The week ahead: what to watch out for
The main releases to look forward to this week are business sentiment surveys, final US GDP figures for Q2, and the Fed’s favoured inflation measure, the US Personal Consumption Expenditure (PCE) deflator. The Purchasing Managers’ Indices (PMIs) are expected to show steady trends, with manufacturing projected to remain soft and services should continue to show steady growth. Within these, European PMIs are expected to remain softer than the US. On inflation, the US PCE deflator is expected to come in at 0.1% month-on-month, with the year-on-year figure at 2.3% – down from 2.5% last month. Core PCE is forecast to tick up slightly to 0.2% month-on-month and to 2.7% year-on-year from 2.6% last month.
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