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Fed Rate Cut Bets, Elections Impact, and Inflation Trends in 2024
Dr. Mahnoosh Mirghaemi
July 15, 2024
6 min read
Last week, the bond market rallied, and stocks gained, fuelled by the latest jobs report, strengthening bets that the Federal Reserve will cut interest rates this year. Treasury yields dropped across the curve as data showed U.S. hiring moderated in June, with prior months revised lower. The economy shows signs of cooling, but so does inflation, creating a nuanced backdrop for investors.
Economic Cooling: The U.S. economy seems to be slowing from its post-pandemic strength, with notable moderation in the services sector and the labour market.
Inflation Trends: Inflation appears poised to resume a gradual cooling path, which is favourable for market stability.
Labour Market Dynamics: The U.S. labour market shows signs of cooling but remains robust overall, with unemployment ticking higher but still below long-term averages.
Economic Growth: The ISM Services Index came in at 48.8 for June, indicating a contraction in the non-manufacturing economy. The softer trends in economic indicators suggest U.S. growth is poised to cool to below-trend levels of 1.5% to 2%. The Atlanta Fed GDP Now tracker indicates second-quarter GDP growth is on pace for 1.5%, following a 1.4% annualised growth rate in Q1. While these rates are below last year’s average, they still represent a positive trajectory.
Inflation: Signs of moderating inflation are emerging, with key indicators such as the ISM prices paid indexes and wage growth figures pointing to a potential easing of inflation ahead. Next week’s CPI report will be crucial in confirming this trend.
Labour Market: Non farm Jobs added 206,000 in June,below the previous month’s revised 218,000. The unemployment rate rose to 4.1%,slightly above the Fed’s 4% estimate. The Fed and markets see the labour market’s gradual cooling as favourable. Improved job supply and more moderate demand for labour imply a balanced market, supporting lower inflationary pressures.
The probability of a September rate cut has risen, with CME Fed Watch indicating a 72% chance, up from 58% last week.History suggests markets can perform well in an environment of cooling but positive economic growth, moderating inflation, and a Fed poised to cut rates.Lower rates and inflation can lead to increased economic activity and positive earnings growth revisions.
Equities: With economic growth potentially softening, mega-cap technology and growth sectors, particularly those delivering on earnings, are expected to perform well, in our view. Cyclical sectors tied to economic growth may face headwinds until the Fed lowers rates,potentially boosting consumption.
Fixed Income: We favour longer-duration bonds within the investment-grade space. These may perform well as economic growth cools and yields soften, and as the Fed pivots to rate cuts. Bonds are expected to provide a meaningful source of income for long-term investors.
U.K. Elections: The U.K. election was never a major concern for traders, as the risk premium assigned in the run-up was next to zero. Lessons were learned from the market turmoil triggered by unfunded tax cuts proposed by Prime Minister Liz Truss back in 2022. The recent land slide victory for the Labour Party has spurred hopes that political stability could support a potential rebound in economic growth. However, the U.K.’s export-oriented FTSE 100 erased gains as the pound hit a session high,reflecting the complexities ahead.
French Elections: Sunday’s run-off in the French parliamentary election may bring more clarity on the next government, but market risks are unlikely to ease quickly. The worst-case scenario – an absolute majority for Marine Le Pen’s far-right National Rally – seems to be avoided. However, political gridlock could prevent France from addressing its budget deficit and halt President Emmanuel Macron’s pro-business reforms. The CAC 40 Index remains the worst performer among major European bourses since Macron called a snap election last month. Market volatility remains elevated compared to Germany’s DAX index. The CAC 40’s valuation premium has diminished,making French stocks potentially attractive for investors looking beyond short-term risks.
U.S. Political Landscape: In the U.S., speculation continues over President Joe Biden’s potential re-election bid. The debate over his candidacy affects market sentiments, with investors evaluating the implications of a Biden or Harris nomination. Policy continuity and the Democratic agenda’s impact on taxes, regulation, and economic growth are key considerations.
Friday’s payroll report introduced mixed signals, showing strong payroll growth but rising unemployment. The economy’s current state is ambiguous, prompting questions about whether this signals a slowdown or deeper trouble. Euro options indicate low volatility expectations for the second round of the French elections, and market focus is shifting to the Fed’s upcoming rate decisions.
Market Reaction: Yields initially fluctuated on payroll data before heading lower. The two-year yield tested 4.73% before falling to 4.62%. The rise in the unemployment rate to 4.1% is consistent with historical recession indicators, prompting a spike in equity futures. The cooling labour market supports expectations for lower interest rates later this year.
Balanced Portfolios continue to be the core investment for households, offering stability and income.
Equities: Favour large-cap and mid-cap U.S.equities over the medium term, with a focus on sectors delivering on earnings.
Fixed Income: Favour longer-duration investment-grade bonds, providing stable income in a cooling economic environment.
Investors should remain vigilant,focusing on sectors and assets that can weather economic cooling and benefit from potential Fed rate cuts. A balanced approach, emphasising quality and diversification, will be key to navigating the evolving market landscape. Stay tuned for next week’s CPI report, which will provide further insights into the inflation outlook and potential Fed policy actions.
