Sea of Red

August 05, 2024

Elias Haddad

Sea of Red

Worries the Fed is reacting too slowly to early signs of softer US economic activity remains the dominant financial market theme.

Today, the US July ISM services index will either reinforce or ease markets’ concern that the Fed is behind the curve.

China services sector activity quickened in July.

Please see our Drivers for the Week Ahead for an in-depth look at what markets are facing this week.

Financial markets are increasingly worried the Fed is behind the curve and reacting too slowly to early signs of softer US economic activity. Last week, the July ISM index showed the contraction in manufacturing activity deepened and the non-farm payrolls report pointed to worsening job market conditions.

USD is down near a five-month low largely driven by strength in the safe haven JPY and CHF. The global equity market sell-off and bond market rally are intensifying while Brent crude oil prices hit its lowest level since early January.

Today, the US July ISM services index (3:00pm London) will either reinforce or ease markets’ concern that the Fed may be too slow to lower the policy rate. The ISM Services index is projected to recover to 51.0 vs. 48.8 in June. The already released regional Fed services business surveys point to downside risks. However, the US S&P Global services PMI rose to a 28-month high at 56.0 in July vs. 55.3 in June.

Fed funds futures have virtually fully priced-in 50bps of rate cuts at the next September 18 FOMC meeting and a total of almost 125bps of easing by year-end. In our view, the US economy is holding up reasonably well suggesting the Fed is unlikely to slash the funds rate as much as is currently priced-in. The Atlanta Fed's GDPNow model is tracking Q3 growth (seasonally adjusted annual rate) at 2.5% following real GDP growth of 2.8% in Q2. Moreover, the US job opening rate is steady near pre-pandemic levels at 4.9% and not consistent with a material increase in the unemployment rate.

We don’t expect any major surprises from the Fed’s Senior Loan Officer Opinion Survey (7:00pm London). The results will offer an overview of bank lending practices over Q3. The June FOMC meeting minutes pointed out that consumer credit remained generally available despite some signs of tightening. Credit also remained largely available to commercial real estate (CRE) borrowers outside of construction and land development loans.

Look-out later today for comments by Chicago Fed President Austan Goolsbee (1:30pm London), and San Francisco Fed President Mary Daly (10:00pm London). Both Fed officials are expected to push-back against cutting the funds rate by 50bps increments.

EUR/USD is up near the top-end of its year-to-date 1.0600-1.1000 trading range. Second-tier Eurozone economic data are released today: August Sentix investor confidence index (9:30am London) and June PPI print (10:00am London).

AUD/USD is heavy under 0.6500 on poor global manufacturing activity and rising expectations of a lower RBA policy interest rate. The global manufacturing PMI slipped in July below the 50.0 boom/bust level for the first time this year. Meanwhile, the Melbourne Institute Monthly Inflation Gauge revealed that inflation re-entered the RBA’s 2-3% target band after falling to 2.8% in July from 3.2% in June.

The RBA interest rate decision is the next domestic highlight (tomorrow, 5:30am London). The RBA is expected to keep rates steady at 4.35%. We also anticipate the RBA to stick to its neutral policy guidance because Australia Q2 inflation remains above the RBA’s 2-3% target and is largely tracking the RBA’s forecasts. The RBA will publish new sets of forecasts in its August Statement on Monetary Policy.

Specifically, we expect the RBA to reiterate that “the Board is not ruling anything in or out”, reiterate “that it will be some time yet before inflation is sustainably in the target range, and warn again of “the need to remain vigilant to upside risks to inflation.”

The risk in our view is RBA Governor Bullock points-out during her post-meeting press conference that the option of raising rates was not on the table. If so, Australian interest rate expectations can adjust lower against AUD. Cash rate futures imply 20% odds of a cut tomorrow and a total of almost 50bps of easing by year-end.

USD/CNH is down to near its lowest level since early January. The expansion in China’s private sector gained traction as the Caixin Services PMI rose more than expected to 52.1 in July (consensus: 51.5) from 51.2 in June.

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