The universally expected cut in Federal Reserve overnight rates actually triggered a sell off in US bonds and a rally in the dollar.
It seems that markets had been primed for an even more dovish outcome, and the single vote among committee members for a jumbo 50bp cut did not satisfy them. Stocks rallied again, however. The dollar rebounded, and the trading range that has been in place since early summer seems to remain firmly in place for now.
This week is unusually light in economic reports. The main focus will be the release of the PMI indices of business activity worldwide on Tuesday. These are the main leading indicators of growth in the advanced economies, particularly in Europe. Beyond that, we will be closely following the US bond market, where medium and long-term rates seem to be ignoring Federal Reserve cuts for now and remain stubbornly high.
GBP
The Bank of England remained in a wait-and-see stance. Inflation printed, as expected, nearer to 4% than 3% in both the headline and core measures, consistent with a stagflationary context that makes it difficult for the central bank to justify further cuts. There were contradictory messages in the UK labour market report last week.
While survey measures suggest robust expansion of employment, tax data on payrolled employees showed another small monthly contraction. No such ambiguity was on display in the government budget numbers for August, which showed that expenditure and the deficit continue to outpace all predictions. All in all, we think that the downside risks to the pound are finely balanced by support from high interest rates and cheap valuation by most measures.
EUR
After the ECB cut rates to what appears to be the cycle low of 2%, the Eurozone seems to have dropped off somewhat from the newsflow driving currency markets.
Economic growth is sluggish and just about sufficient to keep the Eurozone from falling into a recession, supported by still strong employment and services spending. The PMI indices out on Tuesday will give us a fresh read into the state of the Eurozone economy.
USD
Markets had diverging reactions to the widely expected 25bp Federal Reserve cut last week. Stocks chose to interpret it bullishly, as they seem to do with every single piece of news lately, and rallied to fresh records.
Bonds, however, seemed to be disappointed by the fact that only the most recent Trump appointee to the board voted for a 50bp cut, and by the wide dispersion of expectations evident in the "dot plot", which suggests deep divisions about whether to prioritise above-target inflation or the weakening labour market. This week's August PCE inflation report, out on Thursday, will be the main focus of attention for the US dollar.
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