The Fed reduced official rates by 50 bp in their September meeting, surprising all but nine of the 101 economists surveyed before the decision. The majority feared that a 50 pb move would send the message that the economy is about to enter a sharper downturn. However, rather than spook the markets, Jerome Powell was careful to indicate that the bigger move was merely a recalibration, as he would have cut by 25 bp in July had he known the labour data at the time.
The Fed’s decision brings it in line with several central banks, including the European Union, the UK, Canada, New Zealand, Denmark, Switzerland and China. This global synchronised easing cycle signals that monetary authorities are much less worried about inflation than they have been in the past. And for good reason. Inflation in the US has dropped from a high of 9.1% in 2020 all the way down to 2.5%, and in the Eurozone, the trend has been even more impressive with the headline indicator falling from 10.6% to below the 2% target. While core inflation (which excludes more volatile factors such as energy and food prices) has been stickier, with services inflation still at higher levels, central banks feel confident that they have won the battle against inflation and can now focus on sustaining growth.
Unlike in many US easing cycles in the past, rate cuts are coming while economic growth is still relatively healthy. The economy has shown some signs of weakening in the labour market, with nonfarm payrolls trending lower and the unemployment rate creeping up. In addition, disposable real income is coming down and the savings rate is at a low, which does not bode well for discretionary spending going forward. However, none of the data has been alarming and the Federal Reserve hopes to be able to orchestrate a soft landing.
The economic situation in the Euro Area, by contrast, does not look so bright. September’s composite PMI was in contractionary territory for the first time in seven months, suggesting that the Eurozone business cycle is faltering. In Germany, all subcomponents worsened and weakness in the automotive and construction sectors continues to underperform the rest of the region by a wide margin. In France, the boost from the Olympics was short lived and political uncertainty has raised downside risks. Its budget deficit risks overshooting 6% of GDP this year and, be it through spending cuts or higher taxes, the measures to rein in the fiscal shortfall will affect growth.
On the positive side, China’s government announced its biggest monetary stimulus measures since the Covid-19 pandemic and signalled that more fiscal support will come, proving the leaders’ determination in reviving the country’s troubled economy. However, it may not be enough to change the situation in the region. Households and corporations may still not want to borrow, and banks may not want to lend even if interest rates are lower. Moreover, many of the issues China is facing are structural, especially in the property market and housing demand is unlikely to see any meaningful revival just because of lower mortgage rates and down payment requirements. Property prices are still too high and there is an excess of supply.
The overall picture, therefore, continues to be one of slowing growth and it is yet to be seen whether central banks can manage a soft landing. As always, they are walking a tightrope. Easing monetary policy too quickly could reignite inflation, yet going too slowly could cause the slowdown to worsen. Not to mention the geopolitical tensions and the US elections that are posing further risks to both inflation and growth. So, we will continue to monitor data closely to see how the situation unfolds, but the level of uncertainty remains high.
Date of report: October 7th 2024