Stock markets sold off sharply last week, and sentiment drained from the market after another worse than expected payrolls report for August. As we start a new week, stock index futures currently point to a mild recovery for European and US stocks, however, September is proving to be a volatile month for stocks and commodities.
Investors are adjusting to a new normal where the focus is on economic growth and not just inflation. This is why small downside surprises for economic data in the US and elsewhere, are read as signs that a recession is coming. This has been felt in the tech sector, with big tech names selling off. Other sectors that are more correlated to the economy are outperforming the ‘not so magnificent 7’, and this trend continue this week. The market reduced their expectations of a 50bp rate cut from the Fed on 18th September to 29%, but there are still more than 110bps of rate cuts expected from the Fed for the rest of this year, which is a sign that recession fears are gathering pace.
After the excitement of payrolls, there is something for everyone in financial markets this week. Some key economic indicators will be scrutinized for what it means for growth in the UK and the US. A rate cut is expected from the ECB, the first US election debate between Kamala Harris and Donald Trump takes place, inflation data in the US and a raft of key UK economic data, including the latest monthly GDP report and labour market figures.
ECB set to cut rates, but what will come next?
The ECB decision seems like a foregone conclusion after the Q2 wage data for the currency bloc was weaker than expected. Employee compensation grew at a 4.3% annual rate in Q2, down from 4.8% in Q1. This is lower than the 5.1% growth rate expected by the ECB at their meeting in June. Wage pressure has been a key driver of Eurozone inflation this year, and now that it is retreating it could allow the ECB to embark on a prolonged rate cutting cycle. Added to this, growth in Q2 was weaker than expected, rising by 0.2%, down from the 0.3% initial reading. To put this in context, the Eurozone grew at a third of the GDP rate for the UK for Q2. The market is expecting a 25bp rate cut at this Thursday’s meeting, the second rate cut of the year, with just over one more cut priced in by the market for Q4. The expected cut to rates on Thursday would bring down the deposit rate to 3.5% from 3.75%.
The ECB remains divided
The market is convinced that a cut is coming. The doves on the ECB committee have been vocal in their support for a rate cut, including Panetta, Centeno and Stoumaras, while the hawks have not directly spoken out against cutting rates. However, we continue to think that there will be robust debate at the ECB. The hawks including Germany’s Schnabel and Nagel, and Knot of the Netherlands, have urged caution when it comes to rate cuts. Interestingly, although the German economy is contracting and manufacturing activity has plummeted, German ECB members remain the most ardent hawks. Although wage growth is slowing, it is still well above the ECB’s target rate of 2%, and the concern is that wage growth could pick up in Q3, especially in Germany. Thus, while we expect a rate cut on Thursday, the ECB may not provide forward guidance, and instead say that they remain data dependent for the rest of this year. This may limit any upside to European stocks, which we believe will continue to be driven by global themes.
UK wage growth to ease inflation fears
UK labour market data is scheduled for release on Tuesday. Expectations are for the unemployment rate to fall back slightly to 4.1% from 4.2%, and for average weekly earnings growth excluding bonus payments to moderate to 5.1% in the three months to July, from 5.4% prior. This is still elevated and remains well above the BOE’s 2% inflation target rate. However, it is worth noting that real pay, adjusted for inflation, is much closer to the BOE’s target inflation rate, and was 2.4% last month. Thus, another decline in nominal pay could ease UK inflation fears and allow the BOE to cut rates later this year, although we still believe that they will cut rates at a slower pace than the ECB and the Federal Reserve.
UK growth expected to moderate, but BoE likely to remain wary of rate cuts
The UK economy has bounced back in the first two quarters of the year, this week we will see if growth can be sustained in Q3. The monthly GDP reading for July is expected to show a 0.2% MoM expansion, with the 3-month expansion still expanding by 0.6%. Stronger than expected growth in the first half of this year is keeping a cap on expectations for interest rate cuts by the BOE, with only 49bps of cuts expected for the rest of this year, but the risk could be to the downside. The market expects the UK to return to full capacity at the end of this year, which means that any upside surprise to GDP between now and the end of the year could be inflationary, which may delay the pace of BOE rate cuts. This week’s GDP is worth watching closely. An upside surprise could boost the pound. GBP/USD closed the week just above $1.31, however, a strong GDP report could send this pair back towards $1.32. The pound is currently one of the top performers in the G10 FX space so far in Q3.
US: The Harris/Trump debate puts politics back in focus
It’s been a tumultuous summer for markets and for politics. Democratic candidate President Biden bowed out of the race, Vice President Kamala Harris took his place and Trump has seen his support get eroded in the key swing states, according to national polls. This Tuesday evening, we get the first election debate between Harris and Trump. Although Trump was considered the clear winner in the first debate, this was mostly because of Biden’s catastrophic performance, which ultimately cost him his candidacy. Trump’s performance was far from stellar, and this is something that Harris may try to exploit on Tuesday. Harris’s time as a prosecutor in California means she is a threat to Trump in this debate, and she could cut through some of his bluster, which may see her come out on top. While some argue that debates don’t correlate to election outcomes, Hilary Clinton won all her debate performances vs. Trump in 2016, Kamala Harris is still an unknown quantity to the US public. If she can put in a strong performance on Tuesday night, then it may help her campaign gain some upside momentum, which has slipped in recent weeks.
Which candidate is better for stock markets?
As the US election draws closer, the focus will be on which candidate is better for US financial markets. The future for the US Treasury market will be determined by what both candidates pledge to do about fiscal prudence, now that the US Budget deficit is nearly 6% of GDP. Analysis suggests that while both candidates’ policies would boost the budget deficit, Kamala Harris would be the most fiscally prudent, as Trump’s promised tax cuts would boost Treasury issuance. This could ultimately spook markets and may put upward pressure on bond yields. Rising bond yields did not stop a US stock market rally in recent years, however, with the focus on the prospects of a US recession in 2025, and a shift in stock market leadership, with non-tech sectors outperforming in recent months, a rising US budget deficit may complicate the outlook for the US stock market as we move towards the final months of the year. Thus, while it is difficult to make assumptions about which president will be better for US financial asset prices, we think that a division of power: with the White House and Congress controlled by different parties, will be the best long-term outcome for US equity markets.
Inflation data in the US is also worth watching this week. We do not think that it will stand in the way of a Fed rate cut next week, and the market is expecting a reading for headline CPI of 2.6% YoY for August, down from 2.9% in July, and for annual core price growth to remain at 3.2%. Shelter prices are expected to continue their mild downward trajectory, used car prices and consumer goods prices are also expected to have moderated last month. While a rate cut from the Fed in September is now fully priced in, the focus will shift to whether the Fed will turbo charge cuts in November and December, with two 50bp cuts currently priced in by the Fed Funds Futures market. A weaker than expected CPI reading on Wednesday could also boost prospects of a September 50bp rate cut, which may help the current leadership shift in the S&P 500. In the past month, Starbucks, Best Buy and Southwest Airlines have led the stock market higher, the latter has risen by more than 22%. In the last week, the sell off in big tech and especially AI chip makers has gathered steam. Nvidia closed down another 4% on Friday and the semiconductor index on the S&P 500 was the weakest performing sector on the S&P 500, falling 11%. Change is afoot in the US stock market, and this week could determine what comes next.
Read More: Politics, rate cuts and economic data