The unexpected rebound in US purchasing managers’ indices (PMI) in May added further to the long-standing haze over the likely timing of the first cut in the US Federal Reserve’s policy rate. The unexpectedly firm PMI readings weighed on valuations of bonds and equities. They further complicate the task of establishing strong convictions on the economic outlook. All the more so as a recession in the US during the coming 12 months appears to have been ruled out.
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Waiting for US inflation (again)
Yes, again! April’s consumer price index (CPI) reading was in line with market expectations, bringing relief after three consecutive months of US inflation surprising to the upside. The release provided some reassurance. It did not last long.
While retail sales data suggested a possible slowdown in US consumption early in the second quarter, the preliminary PMI results for May, released last week, far exceeded expectations.
After four consecutive declines, the services sector PMI rose by 3.5 points to 54.8, its highest in a year. With the manufacturing index rising by 0.9 point to 50.9, the US composite PMI stood at 54.4, its highest in more than two years.
In addition, price indices continued to accelerate, particularly for input prices in the manufacturing sector. This led investors to push back their expectations of when the Fed may start easing monetary policy.
(Perhaps) just two US policy rate cuts in 2024?
Markets have revised their expectations of a US rate cut: nothing is expected in June or July while the probability of the Fed cutting in September is now priced at only around 50%. Furthermore, since the release of the PMIs, very few market economists at major brokerages are predicting a rate cut as soon as July.
Fed Chair Jerome Powell reminded markets that the Fed is ‘data dependent’. He appeared cautious – indeed, highly attentive to economic data – in recent comments: While at the end of March he has adjudged the latest inflation data as being ‘definitely more along lines of what we want to see’, he had to acknowledge in early May that progress on inflation was disappointing.
The minutes of the policymaking Federal Open Market Committee meeting on 30 April-1 May revealed that given ‘disappointing readings on inflation over the first quarter,’ participants assessed that ‘it would take longer than previously anticipated for them to gain greater confidence that inflation was moving sustainably toward 2%’.
However, observers perhaps overreacted to the comment that ‘various’ participants noted ‘a willingness to tighten policy further’. They overlooked the rest of the sentence: ‘…should risks to inflation materialise in a way that such an action became appropriate.’
Essentially, the Fed’s message of patience and prudence prevailed. It is likely to continue to be the tone emanating from the next meeting of the Federal Open Markets Committee (FOMC) on 11-12 June.
A blurred picture for rate cuts from the European Central Bank, too
Almost all members of the ECB’s Governing Council have effectively preannounced a cut in key rates on 6 June. With the policy meeting just one week away, it is hard to see what might prevent it.
However, market concerns over the likely pace of cuts beyond June have heightened in recent days. While in mid-May, futures markets reflected three ECB rate cuts in 2024, this had slipped to just 2.3 expected cuts by 24 May.
As often happens when markets are nervous (currently mainly due to fluctuating expectations about the Fed’s monetary policy), there is every reason to worry. Last week, European bond markets weakened after the release on 22 May of a higher-than-expected consumer price index… in non-EU member the UK.
And eurozone bond yields continued to rise on another indicator – wage levels. This is not usually a market mover. This time it was the subject of much discussion.
Negotiated first-quarter wage increases in the eurozone (at 4.7% year-on-year after 4.5% in the previous quarter) were steeper than expected, although this surprise was mainly due to higher wages negotiated in Germany (see Exhibit 4).
The ECB provided some comfort; in a blog post, it explained the surge in negotiated wages and highlighted that ‘the increase in wage growth after the pandemic was initially driven primarily by so-called wage drift (i.e. elements not agreed via collective bargaining such as individual bonus payments or changes in overtime) that usually reacts quickly to changes in economic conditions’.
The ECB forecasts a moderate slowdown in wage rises and appears not to think that ‘wage drift’ will affect that outlook. Bear in mind that a few months ago, the central bank was explaining it needed to wait for Spring wage data to decide on monetary policy.
The ECB has clearly decided to rely on its own forecasts. These will be updated at the Governors’ meeting on 6 June. The Fed, on the other hand, focuses on the data (a little too much?).
One wonders whether all this apparent dithering is covering up delicate negotiations within the Fed and the ECB. That leaves investors in need of robust enough information to be able to agree on a solid monetary policy scenario for the months to come.
