Pre-emptive vs Reactive

The early August equity market shock may already feel like a distant memory, but some key market metrics have changed over the summer: the expected trajectory for the Fed is now much more dovish. Jay Powell in Jackson Hole chose not to stick to a cautious, gradualist approach, making it plain that the Fed has “ample” room for manoeuvre to act and will not necessarily wait for more obvious signs of a downturn to cut aggressively. Yet, while we know that the Fed is ready to support the economy decisively, it is still not obvious it will have to. The August payroll, out this Friday, will be important of course, but so far unemployment benefits claims remain tame, consistent with the notion that the ongoing rise in the unemployment rate is essentially driven by the supply-side, while the dataflow on economic activity in Q3 remains decent. We stick to our view the Fed will cut only twice this year, albeit with a significant risk of a third one. Meanwhile, Kamala Harris’ lead in the polls may have contributed to taking US 10-year yields under 4%, since her victory would probably usher in a less spendthrift fiscal policy than Donald Trump’s, and of course less tariff hike. It remains a very tight race though.

Paradoxically, while the ECB chose not to wait for the Fed and cut in June already, its messaging has become very cautious on the next steps since then. The latest dataflow should however make a September cut easier. Yet, we note how prudent some influential board members such as Isabel Schnabel remain. They have of course a point on inflation – the good news is very recent – but we are more concerned on the risks for growth than they are. For now, the nice rebound in purchasing power triggered by the wedge between wage growth and inflation is not being spent by households. If one adds to the mix slower global demand and the prospects of fiscal restriction, we think the ECB should not take too much time to bring the policy rate closer to neutral, but that is a normative view, and we need to pay attention to the hawks’ signals. We do not expect more than three 25bp cuts in total this year. 

Finally, the political process in France may be finally moving on after a long summer break, but whatever the name of the new Prime Minister, policymaking is likely to remain delicate in Paris.