Key events in developed markets next week

The US economy is in good shape with the robust growth, unemployment near 50-year lows and equity markets at all-time highs, yet the Federal Reserve is worried. Weaker external demand and concerns over the impact of protracted trade tensions mean that the Fed is prepared to step in with some precautionary policy easing – the first rate cuts since the financial crisis. Proponents, including the President, argue such a move would ensure that the current growth cycle, which is the longest since records began in 1854, can continue a good while longer. After all the inflation backdrop is benign and with markets fully pricing in four cuts by the end of next year there is a risk that if the Fed doesn’t ease we actually see financial conditions tighten, which would be bad news for growth. The Fed is likely to ease again in September in our view, but thereafter the outlook is more uncertain. If trade talks conclude positively this will remove a dark cloud that has been hanging over the economy and the boost to sentiment it generates would be good news for asset prices and President Trump’s prospects of winning re-election in 2020. Should talks falter and the economy really starts to struggle then the Fed will need to do more to support growth. For now we are in the camp favouring the former.

The FOMC meeting will overshadow the data this week, although there are some very important numbers. The ISM manufacturing index should rebound given the trade truce and the subsequent improvement seen in some of the regional surveys. The jobs report should also show ongoing job creation, but that the lack of available workers means competition for staff is strong with wages ticking higher. Such outcomes could see a modest steepening of the yield curve as markets modestly price out some of the aggressive policy easing they are currently anticipating.

There will be less than three months left until Brexit when the Bank of England sits down to discuss monetary policy next week, making it very tricky to craft a set of new forecasts and guidance. On the face of it, market pricing – which is now pencilling in a 50% chance of a rate cut this year – is too flat for policymakers’ liking. The Bank’s May forecasts were already highlighting excess demand at the end of the forecast period – an implicit signal that rates may need to rise more quickly. The fact that the swaps curve has flattened significantly since May will only amplify the degree of overheating built into the Bank’s projections.

That begs the question: will the Bank push back against the market’s rate cut speculation – or even point to earlier tightening? We think it’s pretty unlikely. Don’t forget that the Bank’s forecasts are premised on Brexit going smoothly – something that looks increasingly questionable. While it’s tricky for policymakers to comment on the politics, they will probably use a similar tactic to June’s meeting where they pointed towards rising financial market perceptions of ‘no deal’ as a reason for caution on rates.

We think UK interest rates will most likely stay on hold for the rest of this year.

A whole batch of eurozone data will be released next week, inconveniently just after the ECB rate decision. GDP for the second quarter will be much anticipated as the first quarter had come in surprisingly strong but intermediate data has been dismal. We expect growth to have slipped in the second quarter. Inflation will be released for July, which will show whether subdued growth still translates into weak core inflation growth despite higher wages. Finally, keep an eye out for unemployment. As long as the labour market continues to perform quite well, service sector growth is likely to maintain a decent pace. That seems quite necessary as industrial production is still well below its December 2017 peak.