Powell rodeo delivers 50bps

Welcome back to SovereignBeat!

• Powell delivers—are back-to-back rate cuts on the horizon?

• Asia markets soar after Fed’s rate cut

• China holds rates steady as economic troubles deepen

• Equity indexes surge: Dow hits an all-time high

• Oil rises but remains below key producers’ breakeven prices for fiscal balance

• IMF indefinitely postpones consultations with Russia

Let’s dissect

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Markets Snapshot

Macro and Fixed Income Markets

• US: In a significant and long-awaited move, the Fed cut the funds rate by 50 bps to 4.75%-5%, the first reduction since March 2020. The move was backed by 11 of the 12 Fed voting members, with Governor Michelle Bowman advocating for a quarter-point increase. Bowman's dissent marked the first by a Fed governor since 2005. Markets further expect cuts during Fed meetings in early November and mid-December.

• Altough Fed Chair Powell emphasized the economy's continued strength, he also cautioned that further aggressive cuts were not guaranteed and that 50 bps reductions shouldn't be seen as a "new pace." Powell's assessment is that the "economy is solid," and risks to the growth and inflation outlook are "roughly in balance." However, it doesn’t explain why the central bank cut by 50 bps instead of 25 bps and may suggest that the Fed is actually more concerned about potential growth slowdowns rather than seeing risks as balanced.

• During the press conference, Powell faced repeated questions about the unusual decision to start a cutting cycle with a larger reduction in rates but was reluctant to acknowledge that the 50 bps move was a catch-up for not cutting rates in July or that the Fed was behind the curve. Policymakers expect GDP growth to hold around 2% in the coming years, despite a sharper revision to unemployment.

• The USD index (DXY) is currently at 100.6, close to a 14-month low, pressured by a rally in risk assets after the Fed's significant rate cut, which has also increased expectations of a soft landing for the US economy.

• The cut also steepened the yield curve further. Since mid-2022, the yield on the 2-year U.S. Treasury note had been higher than that of the longer-duration 10-year Treasury, leading to a a yield curve inversion. However, on September 4, the 2-year yield fell back below the 10-year yield and has stayed there, with Friday’s closing yields at 3.60% for the 2-year and 3.74% for the 10-year.

• Following the Fed’s move to ease policy, Asian currencies have strengthened, led by the Indonesian rupiah and South Korean won, with the Malaysian ringgit reaching its highest level since 2022. The rally is driven by a weaker USD and strong manufacturing data across Asia, signaling solid growth prospects. This favorable environment may allow local central banks to cut rates further without weakening their currencies. Additionally, BancTrust & Co. suggests a larger rate cut could make international capital markets more appealing to African countries like Nigeria and Angola.

• August Personal Consumption Expenditures (PCE) Price Index report is set to be released on Friday by the Bureau of Economic Analysis and will indicate whether the recent easing of inflationary pressures continued into August. The latest report for July showed that the PCE increased at an annual rate of 2.6%, excluding energy and food prices.

• China: The country chose to keep interest rates steady on Friday, surprising many economists amid the ongoing economic slowdown. The People's Bank of China (PBoC) maintained the one-year loan prime rate (LPR) at 3.35% and the five-year LPR at 3.85%. Nearly 70% of Reuters respondents had predicted a cut earlier in the week. A series of disappointing August economic data, including credit lending and activity indicators, heightened the need for more stimulus to support the world's second-largest economy. Analysts still anticipate that Chinese policymakers will enhance measures to help the economy achieve the increasingly challenging growth target of 5% for 2024. Whether the PBoC’s decision is simply a pause before implementing broader stimulus measures remains uncertain, but it has pushed the offshore yuan to a new 16-month high, likely an unwelcome outcome for China.

• Japan: Less surprisingly, the Bank of Japan left policy settings unchanged on Friday, refraining from further tightening after its July increase and hawkish views spooked investors. Core inflation rose to 2.8% in August, in line with forecasts. With BOJ officials in no hurry to 'normalize' ultra-low rates, the yen weakened, nearing 144 per dollar following the decision.

• UK: On Thursday, the Bank of England refrained from making its second rate cut of the year, keeping an eye on the new Labour government's first budget next month, which lifted sterling to its highest levels since March 2022. Governor Andrew Bailey said that he is optimistic that interest rates in the UK will fall but added that they need to see more evidence of residual inflation pressure disappearing. The UK context for both the BoE's decision and the upcoming budget was mixed: consumer confidence fell to a six-month low, despite August retail sales exceeding forecasts. The fiscal outlook worsened, with larger-than-expected public borrowing last month and government debt reaching 100% of GDP for the first time in 31 years. Following Thursday's BoE decision and the Fed's 50 basis point cut the day before, GBP/USD continues to gather bullish momentum, currently trading above 1.3300 at its highest level since March 2022.

Equity Markets

• Both the S&P 500 and Dow gained about 1.5% for the week, while the NASDAQ rose over 2%, leaving it nearly 4% below its historic peak. These gains primarily followed the Fed's rate cut announcement, with the NASDAQ surging 2.5%, the S&P 500 rising 1.7%, and the Dow increasing 1.3% on Thursday.

Commodity Markets

• Oil: Brent crude oil prices rose 4.36% week-on-week to $74 per barrel, driven by the Fed's rate cut and expectations of lower global interest rates boosting demand. This week's rise pushes the 2024 average oil price to $82 per barrel, exceeding the breakeven levels for Qatar, UAE, and Oman, allowing them to run fiscal surpluses. However, it remains below the breakeven levels for Saudi Arabia, Iraq, and Bahrain, where deficits are expected. Ongoing conflict in the Middle East continues to pose supply risks.

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Global Finance

• South Africa: The central bank lowers its benchmark interest rate by 25 basis points to 8%, marking its first rate cut in four years. This decision is driven by an optimistic inflation outlook, as recent data shows inflation cooling to 4.4% in August, significantly below the central bank's target range midpoint. The cut leads to a firmer currency, trading at 17.47 per USD shortly after the announcement. The bank revises its inflation forecasts down for the coming years, reflecting a benign inflationary environment.

• Turkey: the country plans to host separate discussions with Somalia and Ethiopia to mitigate tensions exacerbated by Ethiopia's maritime agreement with Somaliland, which grants it sea access—a move Somalia views as a violation of its sovereignty. These talks precede another round of negotiations in Ankara, underscoring Turkey's role as a mediator in the region.

• Argentina: The country's economy shrinks by 1.7% in Q2 2024, marking the third consecutive quarter of contraction as the country deepens into recession. Efforts to achieve a zero budget deficit coincide with a significant reduction in public and private consumption, alongside a stark decline in inflation to single digits. However, annual inflation remains high at 236.7%.

• Russia: The IMF indefinitely postpones its first Article IV consultation with Russia, originally scheduled to begin with online discussions in September. This comes after the disapproval among EU member states concerning engagement with Russia following its invasion of Ukraine. The last in-person IMF mission to Russia took place before 2022 full-scale invasion of Ukraine. A few weeks ago, Reuters reported that Ksenia Yudaeva, an adviser to Bank of Russia Governor Elvira Nabiullina, is set to become Russia's new executive director at the International Monetary Fund (IMF), succeeding Moscow's current representative. Yudaeva is currently under U.S. sanctions.

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