All eyes were on central banks this week, with three major central banks poised to announce their interest rate decisions.
Key themes:
- Central banks vary in rate decisions
- US Treasury yields fall to six-month lows
- Gold benefits from anticipated fall in interest rates
- US Manufacturing PMI sees steepest decline in eight months
CENTRAL BANKS NAVIGATE UNCHARTED WATERS
Three major central banks found themselves at a crossroads this week, faced with the daunting task of balancing economic growth with inflation control. Their decisions, however, painted a picture of a global economy grappling with divergent challenges.
The Federal Reserve: steady as she goes
The United States (US) Federal Reserve (Fed) opted to hold interest rates steady, marking yet another pause following its aggressive tightening cycle. While inflation has shown signs of cooling, it still lingers above the Fed’s 2% target, as the Fed patiently, yet attentively, keeps an eye on economic data. The decision reflects a delicate balancing act – the need to curb inflation without stifling economic growth to the point of a recession.
This time, however, the Fed’s stance was somewhat dynamic from what we have witnessed in the past. Fed Chair, Jerome Powell, hinted at a potential rate cut at the next Federal Open Market Committee (FOMC) meeting in September, a signal that caught the attention of investors and businesses alike. This shift in tone reflects the Fed’s growing confidence in the economy’s resilience and its ability to manage bringing inflation sustainably down towards its target level, without inflicting severe economic pain.
The decision to hold rates steady while signalling a potential cut in the near future underscores the Fed’s data-dependent approach. The US central bank is closely monitoring economic indicators, such as employment figures and inflation trends, to inform its future policy decisions, which is in line with the Fed’s mandate.
The Bank of England: an unexpected pivot
Surprisingly, the Bank of England (BoE) cut interest rates for the first time since 2020, following polls that indicated a 60% chance of a cut at the August meeting. This decision contrasted with the Fed’s cautious stance and reflected the unique challenges facing the United Kingdom (UK) economy. While UK inflation has eased, the UK’s central bank remains concerned about persistent wage growth, and stubborn inflation in the services sector, which could lead to a potential rebound in inflation.
The rate cut aims to stimulate economic growth and provide relief to mortgage holders and businesses burdened by high borrowing costs. The BoE’s decision was, however, not unanimous, highlighting the complexities of the country’s economic landscape. Several policymakers expressed concerns about the risks of premature easing, emphasising the need for a more cautious approach.
The UK’s recent election and the subsequent policy changes introduced by the Labour government have added another layer of complexity to the UK’s economic outlook. The BoE faces the challenge of balancing its monetary policy objectives with the government’s fiscal plans, which could have significant implications for inflation and growth.
The Bank of Japan: a departure from ultra-loose policy
An interesting move came from the Bank of Japan (BoJ), which raised interest rates and announced plans to gradually reduce bond purchases. This tightening aims to combat rising inflation expectations, particularly concerning import prices. The BoJ’s decision contrasts with the global trend of easing policy, focusing on preventing an inflation overshoot that could necessitate more drastic measures later.
BoJ Governor, Kazuo Ueda, stated that the BoJ would hike rates further if it becomes convinced that rising wages would prop up service prices. Ueda emphasised that the BoJ aims to reach short-term rates that neither cool nor stimulate growth, seen by analysts as between 0.5% and 1.5% if inflation sustainably hits 2%.
In its most recent statement, the BoJ highlighted that wage hikes were broadening, prompting firms to pass on higher labour costs through increased service prices. Despite some recent moderation, import prices were again accelerating, stressing the need for vigilance. The BoJ maintained its projection that inflation would stay around 2% through to 2026 and indicated that, barring major disruptions, it is on course to tighten further, with another potential interest rate hike by early next year.
A global economic divide
The different paths these central banks have taken reflect the unique economic challenges each country faces. The US is grappling with a slowing economy and persistent inflation, while the UK is balancing the need for economic stimulus with inflation risks. On the other hand, Japan is focused on normalising monetary policy after years of ultra-loose conditions.
As these deviating monetary policies play out, one can expect a notable effect on global financial markets, exchange rates, and trade.
DELVING INTO THE MARKET MOVEMENTS
A shift in monetary policy drives yields lower
On Thursday, the US 10-year Treasury yield fell below 4%, marking its lowest level in six months. This decline came as markets evaluated the Fed’s potential shift in monetary policy. The Fed held the funds rate steady at 5.25% to 5.5% and noted progress towards its 2% inflation target. The ISM Purchasing Managers’ Index (PMI) indicated a sharper-than-expected downturn in the US manufacturing sector, and labour costs rose less than anticipated in the second quarter. These factors bolstered market expectations for three 25 basis point rate cuts this year. The US Treasury maintained its guidance on long-term debt, favouring shorter-term bills to suppress yields despite political challenges from Republican opposition.
In the UK, the 10-year Gilt yield dropped to 3.9%, its lowest level in six months, following a 25 basis point interest rate cut by the BoE to 5%. This decision, though anticipated, was contentious. Traders are betting on further rate cuts totalling 35 basis points by year-end, with the next reduction likely to be in November. However, BoE Governor, Andrew Bailey, cautioned against rapid cuts due to ongoing inflation concerns. Concurrently, the new UK Finance Minister, Rachel Reeves, announced public spending cuts and hinted at upcoming tax hikes to address a £22 billion funding gap.
South Africa’s 10-year government bond yield hovered, slightly above year-to-date lows but remained well below pre-election double-digit levels. Investors anticipate a 25 basis point rate cut in September, with some expecting a larger 50 basis point cut.
Gold glimmers near record highs
Brent crude oil futures fell to $80.40/barrel as demand concerns overshadowed supply-disruption fears from the Middle Eastern conflict. The ISM Manufacturing PMI highlighted a significant contraction in US manufacturing, adding to signs of slowing oil demand from China, where oil imports dropped 11% in the first half of 2024. The Energy Information Agency reported a larger-than-expected 3.43-million-barrel draw in US crude inventories, marking the fifth consecutive week of declines.
Gold prices eased to around $2,440/ounce after a 1.6% rise in the previous session, remaining near record highs. Expectations of a more lenient US monetary policy and safe-haven demand amid Middle Eastern tensions are supporting gold prices. The Fed keeping rates steady, while hinting at potential rate cuts, contributed to this sentiment.
Manufacturing sector contraction weighs on US equities
US stock markets saw the major indices trade in the red, with the S&P 500 and Nasdaq each losing 0.1% and the Dow Jones dropping 270 points. The ISM Manufacturing PMI’s unexpected contraction, along with weak employment data, fuelled economic concerns. US initial jobless claims rose to 249,000, their highest in nearly a year, while labour costs increased less than forecasted in the second quarter. Despite these downturns, social media giant, Meta, saw its shares surge 8% on strong second quarter results, while multi-national semiconductor and telecommunication firm, Qualcomm’s shares fell 5% due to trade concerns. Other notable tech companies – Apple, Amazon, and Intel – were set to report results post-market.
The UK’s FTSE 100 fell over 1% to 8,270 as traders digested the BoE’s statement and poor US manufacturing data. The BoE’s cautious approach to further interest rate cuts and disappointing corporate earnings, including British aerospace manufacturing company, Melrose, and multi-national asset management company, Schroders, weighed on the index.
Germany’s DAX dropped nearly 1.2% to around 18,290, led by declines in the auto sector. BMW’s profit drop, Daimler Truck’s reduced revenue forecast, and VW’s operating profit decline contributed to the downturn. Mail and logistics group, Deutsche Post, also fell 3.8% despite meeting 2024 targets.
The JSE index in South Africa dipped slightly to 82,400, reversing gains from the prior session. Resource linked stocks faced selling pressure, with steel and mining company, ArcelorMittal South Africa reporting significant losses. Dovish comments from the Fed have provided some relief, however, as traders await local manufacturing PMI data.
Dollar rebounds as its peers feel the pressure of interest rate cuts
The US Dollar Index rose to 104.3, rebounding from a 0.4% drop, as traders digested the Fed’s move to keep interest rates steady and its hints of a September rate cut.
The euro fell below $1.079/€, touching one-month lows, amid expectations of at least two more European Central Bank (ECB) rate cuts this year. The ECB left rates unchanged in July, with ECB President, Christine Lagarde, stating the September decision remains open.
The British pound weakened to below $1.28/£ after the BoE’s 25 basis point rate cut to 5%. Traders anticipate further cuts totalling 35 basis points this year, though Governor Bailey warned against rapid reductions due to persistent inflation concerns.
The rand gained momentum against all major currencies towards the close of local trade on Thursday to trade at R18.15/$ at the time of writing.
Key Indicators:
USD/ZAR: 18.19
EUR/ZAR: 19.66
GBP/ZAR: 23.14
GOLD: $2,463.12
BRENT CRUDE: $80.22
Sources: Bloomberg, Reuters, Refinitiv and Trading Economics.
Please note that the Weekly Market Wrap will not be published on Friday, 9 August 2024 due to the National Women’s Day public holiday. We will resume the Weekly Market Wrap on Friday, 16 August 2024.
Written by: Citadel Advisory Partner and Citadel Global Director, Bianca Botes.