Cliff Notes: varied assessments of risk
Key insights from the week that was.
Following a tumultuous start to the week for global markets after a disappointing US employment print (see below), the RBA made clear their views on the risks the Australian economy faces. The RBA’s decision to leave the cash rate unchanged at 4.35% was not the focus for markets, even though the probability of such an outcome was being extensively debated not too long ago. Rather, participants quickly turned to the RBA’s updated assessment of the economy, epitomised by the judgement that “there is more excess demand in the economy and the labour market than previously thought”. Given the RBA’s forecasts for economic growth, trimmed mean inflation and the unemployment rate were only revised at the margin, the foundation of the Board’s reassessment is seemingly model-based estimates of the balance between the level of demand and supply which, in the RBA’s words, have “considerable uncertainty”.
The main takeaway from the RBA’s perspective is that this imbalance is “resulting in persistent inflation”, leading Governor Bullock in a speech the following day to assert that the Board “will not hesitate to raise rates” should there be upside risks around the inflation outlook. Regarding rate cuts, Governor Bullock’s press conference following the decision was forthright, telegraphing that the scenario of a rate-cut by year-end, as per current market pricing, “does not align with [the Board’s] thinking”.
As detailed by Chief Economist Luci Ellis following these developments, we have revised our RBA view, with the first cash rate cut now expected in February 2025 instead of November 2024 – uncertainty around the narrow path to target pointing to a higher hurdle before the Board can be confident in inflation’s deceleration. We still anticipate rate cuts to ensue at a measured pace of 25bps per quarter through to Q4 2025, albeit now to a slightly higher terminal rate of 3.35%.
In the US at the end of last week, non-farm payrolls disappointed, rising 114k (consensus 175k). The prior two months were also revised down by a cumulative 29k. Arguably more unnerving for markets, the unemployment rate rose 0.2ppts to 4.3%, triggering the ‘Sahm Rule’. This indicator states that a recession has started once the three-month moving average of the unemployment rate is 0.5ppts above the lowest three-month average of the past 12 months. This evidence of deteriorating labour market conditions kept participants on guard throughout the week.
FOMC members Goolsbee and Barkin sought to steady sentiment by emphasising that one month's data does not constitute a trend. However, Goolsbee also made it clear he believed policy was materially restrictive and the longer it remains that way, the more policymakers' focus has to turn to the employment side of the mandate. Helping the FOMC’s case by pointing to the resilience of the US economy, the ISM services PMI bounced in July to 51.4, supported by gains in all but two sub-indices in the month. Of particular note, the employment index rose 5pts, breaking a five-month run of contractionary reads. Cheered by the market late in the week, initial jobless claims fell last week and remain near historic lows, providing further support for the view that US employment might be stalling, but there is no evidence of significant aggregate job loss across the economy.
While not a focus for the market, responses to the July Senior Loan Officer Survey were cautious but benign for the growth trend, with "tighter standards and basically unchanged demand for commercial and industrial (C&I) loans" in Q2 and "tighter standards and weaker demand for all commercial real estate (CRE) loan categories". For households, banks reported "basically unchanged lending standards and weaker demand across all categories of residential real estate (RRE) loans and lending standards and demand unchanged for home-equity loans. Demand was unchanged for credit cards, but weakened for other forms of consumer credit.
As US inflation continues to come down and with downside risks growing, there is reason for the FOMC to cut decisively into year end and through early-2025. That said, we remain confident in the underlying health of the US economy and believe the FOMC will too, resulting in a more muted easing cycle than the market currently expects. We continue to expect the first cut to be 25bps in September, but now expect another 25bp cut at each of the meetings through November 2024 to March 2025. One cut per quarter from the June quarter 2025 will leave the fed funds rate at 3.375% end-2025. That is the same terminal rate as we had previously, but it will be reached six months earlier. As long as the labour market remains in good health, which we expect, lower interest rates will boost demand into 2025 and ease banks’ concerns over the outlook.
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