Dovish, but how dovish?

• Bonds broadly rallied, with UK Gilts gaining +0.4%
• Japan was the only equity market to end the week higher in sterling terms, rising +0.4%

• Other equity regions declined, with emerging markets and the US down -1.5% in sterling terms
• Pound sterling strength saw the US dollar, the euro and the Japanese yen head lower

The annual Jackson Hole Symposium took place last week, coinciding with the publication of minutes from July’s Federal Open Market Committee (FOMC) meeting. This comes at a time when markets are very alert to monetary policy, after soft US economic data led to an equity rout, and saw markets price in a double-strength interest rate cut in September, of 50bps. Equities have since rebounded, boosted by stronger economic data, dispelling fears of a collapsing US economy, and interest rate expectations have pared back, but investors are seeking clarity on the path of monetary policy.

The FOMC minutes, released on Wednesday, reiterated the dovish shift already apparent, with “the vast majority” of committee members ready to cut at the September meeting, and “many” believing that policy is currently restrictive. The labour market was the Committees’ top concern, now superseding inflation, while “several assessed that payroll gains may be lower than those needed to keep the unemployment rate constant with a flat labor force participation rate.”

While the minutes shed further light on FOMC members’ interpretation of the soft July payroll data, they cannot reflect the subsequent turbulence in markets, precipitated by a number of factors, including July’s soft payroll report.

Observers hoping for greater clarity from the Chairman of the Federal Reserve, Jerome Powell at Jackson Hole were likely disappointed. While Powell’s tone remained dovish, he reiterated that "rising unemployment has not been the result of elevated layoffs, as is typically the case in an economic downturn." However, Powell clarified that FOMC members “do not seek or welcome further cooling in labor market conditions”.

More recent labour market data has reassured markets somewhat, with initial jobless claims remaining stable. The week of 17 August saw seasonally adjusted claims of 232,000, only modestly higher than the prior week’s reading of 228,000. Unadjusted, claims declined to 191,600.

Markets currently price in a 25bps interest rate cut in September, with a further three cuts priced by year end. This looks ambitious, and could be a source of volatility for financial markets.

The upcoming UK Autumn Budget is keenly anticipated, perhaps more so than usual. The Treasury has already flagged a gap of around £20bn of unfunded spending which is not reflected in official budget figures. The Chancellor has pledged to publish spending plans for the coming tax year and a further spending review for future years will be published in the spring.

The most recent set of public borrowing statistics don’t make matters any easier. Borrowing in the first four months of the 2024/25 fiscal year totaled £4.7bn, above the Budget forecast, with deficits rising in the past three months. Self-assessment tax receipts typically keep borrowing low in July, but receipts came in at £91.0bn, below the Office for Budget’s (OBR) forecast of £92.1bn forecast. While these could rebound in August, borrowing came in higher than expected, with central government spending of £107.4bn, ahead of the OBR’s forecast of £103.4bn.

In July, the Chancellor, Rachel Reeves, indicated the government is likely to borrow £16.5bn more than budgeted for the next fiscal year. The spending review is likely to raise this further, given that current spending plans assume a 1% increase in public spending. Given that some departmental spending is protected, this translates to a 2.3% real terms cut to non-protected areas.

As well as new spending announcements, the Autumn Budget is expected to outline revenue raising measures, including tax increases. Given that Rachel Reeves has pledged not to raise a range of personal taxes, the opportunities for increasing revenue are more limited and increases could be more focused.

Business surveys last week pointed to global activity improving, but a further widening of the gap between services and manufacturing activity. Purchasing Managers Index surveys, which correlate with expansion when above the ‘50’ level, increased to 52.8 at a global developed market level. However, manufacturing indicators continue to broadly fall, while services indicators strengthen. Indeed, manufacturing PMIs remain below 50 in Japan, Europe and the US. Reassuringly, trade data has shown some resilience in Asia, suggesting that technology orders could drive a boost in trade activity. However, so far there is little evidence of this positive momentum fanning out toward the rest of the economy.

 

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