Update Bonds: It's all about the ‘mother of all numbers’
During the annual bankers convention in Jackson Hole, Chair of the US central bank, Jay Powell, made clear that he “will not seek or welcome further cooling in labour market conditions”. As concerns on inflation have eased, his remarks have set the bar lower for more (and decisive) rate cuts.
Given that monetary policy actions take time to take effect, one might wonder whether the US Federal Reserve (Fed) is too late (again) and the cooling in the job market has turned into a cold. This will be answered next Friday (6 September), when the ‘mother of all numbers’, US employment data, will be released. Some days prior to that, the release of ISM data for both manufacturing and services can already offer some indications on the health of the US job market.
The terminal rate (a neutral interest rate that suggests inflation remains stable and full employment is achieved) for year-end 2025 is trading around 3%. This implies more than 200 basis points (bp) of rate cuts. In the meanwhile, credit spreads reject a recessionary environment. For (weaker) companies that rely on short-term refinancing needs, the start of a rate-cutting cycle is positive. This should help the sentiment in credit markets and global equities, which have brushed off recent concerns about a potential US recession quite quickly.
By contrast, rates markets are still pricing in a negative picture for growth. In history, markets only priced this much easing ahead in 2000 and 2008, when the Fed cut the policy rate by at least 500 bp during each cycle. After Powell’s speech, shorter-dated US Treasury yields continued their move down and investors are now not even ruling out a rate cut of over 25 bp on 18 September. We still expect a first cut by 25bp in our base-case scenario.
Spreads between the ten-years French and German government bond yields have stabilized on a higher range due to the increase in political risk, but there seems scope for some further widening based on a long-run correlation with the economic policy uncertainty in France.
Emerging-market bonds currently benefit from improved fundamentals, including a better growth and inflation balance and going forward from a likely more dovish Fed. The improved growth and inflation balance has been rewarded by more credit-rating upgrades than downgrades in the sovereign market. And that central banks will have room to cut further, is a positive sign for emerging-market debt in general.
