A Premature Fed Rate Cut Will Be A Mistake Of Olympic Proportions

By Benjamin Picton, Senior Macro Strategist at Rabobank

Equities pumped on Friday to recover some of the losses posted earlier in the week. The EuroStoxx50 rose 1.06% to 4,863, the S&P500 closed 1.11% higher at 5,459 and the NASDAQ was up 1.03% to 19,023. High beta China-adjacent currencies like the AUD and NZD came in for a battering during the week after a surprise rate cut from the PBOC and a broad selloff in commodities. The Japanese Yen, meanwhile, surged on renewed bets that the BOJ could be poised to say “uncle!” and deliver further monetary tightening as early as this week. Brent crude fell to close at a $81.13/bbl, and spot gold also fell for the second week in a row to close just below the $2,400/oz level (though it is testing resistance there in early trade).

Gold will be on the minds of more people than usual with the Paris Olympics having kicked-off over the weekend. Japan and Australia currently sit at spots 1 and 2 on the medal tally, which might cause hard-money types to facetiously note the correlation between gold demand and too-loose monetary policy. Both countries will be in focus this week as the market keeps a close eye on the outcome of Wednesday’s BOJ meeting and the release of June retail sales figures and the all-important Q2 CPI inflation report for Australia.

The Aussie Q2 CPI number is likely to be make-or-break for the prospects of an RBA hike in August. Anything greater than 1% q-o-q (the market consensus) is going to be very uncomfortable for a central bank that has been too optimistic on its inflation forecasts for two out of the last three quarters, and whose implied forecast this time around is just +0.8% q-o-q.

Elsewhere this week we will also see the FOMC and the BOE in action. The Fed is widely expected to hold rates – particularly after growth and inflation figures released last week surprised on the high side – while the market consensus on the BOE is for the cutting cycle to begin, a view that our own BOE watcher Stefan Koopman shares.

The Fed is in a particularly delicate position. Former Fed Governor – and former rate hawk – Bill Dudley wrote a piece for Bloomberg last week where he said that he had changed his mind and now believes that the Fed should begin cutting rates immediately. Bill’s change of heart coincides with the Democrats’ switch-out of Joe Biden for Kamala Harris as their (presumptive) nominee for the Presidency. The Harris ascendancy might make it awkward for Powell & Co to fast-track policy easing in the leadup to an election contest that has suddenly tightened. Especially since the Trump campaign has previously indicated interest in taking a more interventionist approach on monetary policy.

While the eyes of rates traders will be on central bank decisions, and the eyes of almost everyone else will be on the bread and circuses unfolding in Paris, tensions in the Middle East have again risen after a Hezbollah rocket struck a football field in the Golan Heights, killing twelve Israelis aged between 10 and 20 and injuring dozens of others. Israel has vowed severe retaliation and Israeli Foreign Minister Katz said over the weekend that “we are approaching the moment of an all-out war against Hezbollah and Lebanon” (!).

World leaders are reportedly working frantically behind the scenes to de-escalate tensions, but it is no exaggeration to say that the incident – and Hezbollah’s status as a favourite proxy of Iran – has heightened the possibility of broader war that Rabobank has flagged as an important risk since the October 7th attacks last year. Indeed, Iran’s Foreign Ministry has warned that any Israeli response to the attack could “prepare ground for the expansion of instability, insecurity and flames of war in the region” (!!).

The Hezbollah rocket strike follows similar recent attacks on Israel launched from Yemen by the Iranian-backed Houthis. Those attacks drew retaliatory strikes from Israel on a Houthi-controlled port just over a week ago. The effects of Houthi attacks on Western shipping in the Red Sea – and the subsequent effective closure of the Suez Canal – are by now well known. Surging shipping costs are an artefact of the conflict, but a step up in direct attacks on Israel from Iran’s regional proxies presents renewed risk of supply shocks in the energy complex. If such a supply shock were to occur, it could derail monetary easing as progress in goods disinflation is thrown into reverse while services inflation remains uncomfortably high in many advance economies.

Dual supply shocks in energy and shipping sounds like Covid-era déjà vu that could make premature monetary easing look like a mistake of Olympic proportions, but waiting too long to ease will mount pressure on a floundering commercial real estate sector and households who have run through accumulated savings. Who would be a central banker?

Week Ahead  

Monday: New Zealand filled jobs for June fell by 0.1% while the previous month’s number was revised down from 0% to -0.3%. That presents an interesting setup for the more comprehensive Q2 labour market report due next week. Elsewhere today we have mortgage approvals and money supply figures for the UK and the Dallas Fed’s manufacturing activity index for July.

Tuesday: Japan labour market data and Aussie building approvals kick things off before we head to Europe for the Q2 GDP advance read. Seasonally-adjusted growth of 0.2% q-o-q is expected. That’s a touch lower than the Q1 result, but sufficient to see year-on-year growth rise by one tenth to 0.5%. We will also get CPI reports for Spain and Germany before we head over to the USA for the JOLTS report, the FHFA House Price Index and the Conference Board’s consumer confidence report for July.

Wednesday: The BOJ and FOMC meetings (covered above) are the headliners for the day. We will also see NZ building permits, Aussie Q2 CPI, retail sales and private credit, China PMIs and Japan industrial production. The ECB’s latest economic bulletin, Eurozone unemployment figures and preliminary Eurozone CPI for July will be released with the year-on-year core CPI reading expected to fall modestly to 2.8%. In addition, we get CPI reports for France and Italy, Canadian GDP for May (1% y-o-y expected), the ADP Employment report in the USA (+149k exp) and weekly MBA mortgage application figures.

Thursday: The Bank of England policy rate decision is the key event for the day (25bp cut expected), but Aussie trade figures for June are first up. That’s followed by UK house prices, Caixin manufacturing PMIs for China, Italy unemployment figures for June, the USA’s ISM manufacturing index for July, and the USA’s usual weekly jobless claims figures. BOE Governor Andrew Bailey will be speaking following the Bank Rate announcement, and Huw Pill is also scheduled to give remarks later in the day.

Friday: July non-farm payrolls headlines the day and is expected to print at +178k with the unemployment rate remaining at 4.1%. That follows a stronger-than-expected print of +206k in June, but will we see that revised lower this week? (probably, if form is any guide). Earlier in the trading day we will see Q2 PPI for Australia, industrial production for France and Italy, retail sales for Italy, unemployment figures for Spain, and then both factory orders and durable goods orders for the USA after the payrolls release. The BOE’s Huw Pill will again be speaking.