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3 Sept 2024 | 5 minutes to read
With the US Federal Reserve (Fed) in “data dependent” mode, markets continue to be fixated on US data. Last week’s data continued to offer some reassurance that the economy wasn’t slowing dramatically, while inflation data remains subdued.
On the activity front, revised Gross Domestic Product (GDP) data pointed to greater strength. GDP growth in the second quarter was revised higher to 3.0%, from 2.8%, with the bulk of the upgrade coming from stronger consumption spending. Consumer confidence also improved, though the balance of workers reporting a strong jobs market versus those reporting difficulty finding roles declined. At the same time, initial jobless claims fell in the week to 24 August, with 231,000 claims, down from 233,000.
Areas of continued softness remain durable - goods and housing. Pending home sales fell 5.5% in July, likely reflecting higher mortgage rates and poor affordability.
All in all, this data paints a picture of an economy still in good shape, but with clear pressure on certain areas. Crucially for the Fed, inflation data continues to be in line with forecasts. Personal Consumption Expenditure Price Index (PCE) came in at 0.2% at both a headline and core level in July, representing a good degree of stability. On a year on year basis, this translates to a 2.5% rise for the headline index, and a 2.6% increase for the core component. This means that the Fed is less concerned around the inflation side of the dual mandate, with employment gaining greater attention.
Current pricing continues to imply almost 100bps of interest rate cuts by the end of the year, implying double-sized cuts at one meeting. Market pricing indicates that rates will be cut by a further 100bps by next summer, which would take the Fed Funds close to the level they considered to be the neutral rate. While some meaningful rate cutting is possible, this pricing looks demanding, given that the economy is cooling relatively gradually. This could be a source of volatility if markets reprice.
UK housing data is beginning to show some signs of revival. The Nationwide house price index showed a -0.2% decline in August, after a 0.3% rise in July, translating to a 2.4% year on year increase, the fastest pace of annual growth since December 2022. Mortgage lending data is holding up, with mortgage approvals inching up to 62,000 in July, from 60,000, and net lending rising to 2.8bn from 2.6bn. This improvement in housing sentiment may reflect the Monetary Policy Committee’s decision to interest cut rates in August. While rates had already fallen somewhat ahead of the meeting, reflecting the shape of the futures curve, the initiation of a cut may have lent credence to the expectation of further cuts to come.
While activity in the UK is looking healthy, two headwinds may emerge in the second half of the year. Firstly, inflation is expected to reaccelerate modestly, as base effects are now adding to year-on-year inflation prints rather than detracting. Secondly, the anticipation of tax rises at the October Autumn Budget may dent confidence somewhat, though the Treasury’s plans suggest the impact of tax increases may be focused on areas that will impact economic activity less.
News that OPEC+ countries are expected to unwind production cuts in October caused some volatility last week.
Oil prices have experienced significant volatility in recent years, with prices plummeting at the start of the Covid-19 pandemic, and at one time turning negative, before surging in the subsequent years, as disrupted output and a stronger economic recovery put pressure on supply. The Russian invasion of Ukraine exacerbated this further, sending gas and oil prices higher. Today, the oil price is c. 40% below its 2022 peak level, but 15% above the level seen at the end of 2019.
While OPEC+ countries have a long history of implementing supply quotas to manage the oil price, this has come into greater focus in recent years, given the impact energy prices have had on inflation. While OPEC+ countries have adhered more rigorously to supply quotas than in the past, this may in part reflect the difficulty of some nations to meet the supply quota allotted to them. This has lent greater support to oil prices.
On this occasion, a production increase in October could well be offset by lost production from Libya. Libyan output has declined by around 700,000 barrels a day, a result of the government shutting down oilfields as civil strife escalates.
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