The Federal Reserve is effectively certain to lower rates for the first time since December on Wednesday, with recent jobs data suggesting that the bank is now well behind the curve.
US inflation has been well above Fed targets for the past five years, and is slowly trending higher. Yet, signs of a labour market slowdown continue to pile up, which is piling pressure on the Fed to cut. Stocks somewhat incongruously continue to hit fresh record highs, and the dollar is hanging on, perhaps because its main rivals have trouble of their own, such as continued stagnation in Europe and an even worse bout of stagflation in the UK. The main beneficiary from these general troubles continues to be gold, up a whopping 40% against the US dollar so far this year.
Front and center this week will be the September Federal Reserve meeting, which is universally expected to cut rates for the first time in 2025. We do not expect a jumbo 50bp cut, as that would carry a whiff of panic and perhaps result in a financial market sell off. August US retail sales on Tuesday and weekly jobless claims on Thursday will add further light to the extent of the economic slowdown. A slow week in the Eurozone contrasts with a deluge of labour (Tuesday) and inflation data (Wednesday) out of the UK.
GBP
This week's data deluge will go a long way towards clarifying the state of the UK economy. We expect that the jobs data and inflation report will confirm that the UK is in the middle of a stagflationary process, with inflation remaining far above Bank of England targets while the labour market continues to slow. On the positive side, the sell off in the gilt market seems to have abated and yields have stabilised, though sentiment remains fragile and another Labour fiasco along the lines of its recent failure to deliver modest spending cuts would probably cause the uptrend in yields to resume.
Meanwhile, the Bank of England will keep rates unchanged on Thursday, as it continues to place greater emphasis on the inflation overshoot than the cooling in Britain’s jobs market. We are bracing for a 7-2 vote, and forward guidance that acts to dampen expectations for cuts during the remainder of the year.
EUR
The September meeting of the ECB was the non-event that most market participants were expecting. Lagarde’s press conference was fairly hawkish, as she voiced that the bank was not overly concerned about inflation and that officials believed policy to be in a “good place”. Barring something quite extraordinary, we think that the easing cycle is over and no more cuts are now priced in by swaps markets.
Nevertheless, the closing of the interest rate gap with the US (a positive for the common currency) is now counterbalanced by worries about the French fiscal picture. As in the UK, even modest cuts seem to be politically impossible and the French deficit is the worst in the Eurozone. Already sky high taxation levels make it difficult to close the gap through the usual expedient of tax increases. Fitch's downgrade of France's sovereign rating over the weekend underscores the problem. This week is a quiet one for the Eurozone, so the euro will trade off events elsewhere.
USD
This week's meeting of the Federal Reserve is shaping up to be a crucial one, and not just from the point of view of routine monetary policy. It is not clear whether Governor Cook will be able to participate, as she battles Trump in court over his attempted firing. But the spotlight will be over which aspect of stagflation Chair Powell chooses to focus on: the slowing labour market (a more urgent problem after the BLS revealed that it had massively overstated job gains), or an inflation rate that is still clearly above target.
Chair Powell’s recent remarks suggest that it will be the former, and he will likely tone down his optimism towards the jobs market, while stressing again that any tariff induced increase in inflation will be temporary. We expect the Fed to lay the groundwork for another rate reduction at the next meeting in October. We could also see a fairly significant downward revision to the dot plot, which would put the 2026 median dot much closer in line with market pricing.
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