US interest rate cuts coming

I'm writing this commentary before Fed boss Jay Powell speaks at the famed Jackson Hole conference. With his speech he can set markets in motion. Two years ago, the S&P 500 fell nearly 3,5% after Powell spoke. I don't think that will happen today.

The US Department of Labor published preliminary annual review figures this week (benchmark revision) of employment through March of this year. Economists were already expecting a significant downward adjustment and that expectation came true. There are more than 160 million jobs in the US and employment in March of this year appears to be 818.000 lower (of which 819.000 in the private sector!) than previously reported. This means that you cannot call the labor market weak, but it is less robust than we previously thought. Job growth over the twelve months up to and including March appears not to have been 1,9%, but 1,3%.

This is a relevant fact for the Federal Reserve, which must ensure price stability and contribute to as much employment as possible. Until now, the view has been that inflation is too high and the labor market is very robust. A restrictive monetary policy is then the obvious choice. But the picture now is that the inflation target has almost been achieved and that the labor market is weaker than previously assumed. This argues for a much less restrictive policy.

The minutes of the Fed's rate meeting at the end of July are clear. Although the decision not to change rates at the time was unanimous, some committee members said they would have supported a proposal for a rate cut. Strange course of events: not proposing an interest rate cut, but saying that he would have supported such a proposal if someone else had done so. According to the minutes, a large majority also thought that interest rates would be lowered in September if economic data continued to develop as expected. And for the time being, that is the case or the numbers are even weaker. That interest rate cut will therefore come in September. Although some people think of 50 basis points, a reduction of 25 basis points seems obvious to me. Let's start slowly and certainly not give the impression that there is increased concern within the Fed.

Although all interest rate decisions have recently been taken unanimously, the minutes still show considerable division. Some members argued that the Fed should not wait too long or cut rates too slowly, while other members said the Fed should not cut rates too early or too aggressively. Well, that seems pretty crazy to me. You don't want to be too early and you don't want to be too late. Unfortunately, monetary policy is not an exact science. The minutes also show that there are quite different opinions about what the 'neutral level' of interest rates is. This determines how quickly and to what level the interest rate will be reduced.

Financial markets are pricing in as many as 100 basis points of interest rate cuts before the end of the year. Hopefully Powell will say something about that in Jackson Hole. The market's expectations don't seem that crazy to me. I have argued before that the American economy is starting to show some weaknesses. Not only is the labor market weaker than expected, interest-rate-sensitive sectors are also clearly under pressure. A good example is the housing market. Due to the scarcity of housing, prices are high. The combination of high prices and relatively high interest rates makes the current time particularly unattractive to buy a home, as shown in the first graph, which is based on data from the monthly survey that the University of Michigan conducts to measure consumer confidence.

Olympics
See, I like that. There is a clear economic effect of the Olympic Games in Paris. I have followed and enjoyed many of the proceedings, but as an economist it is nice to see that the Games have also made their way into economic statistics. And I'm not talking about the costs.

This week, S&P Global published preliminary figures on the confidence of purchasing managers in August in various countries. The overall picture does not make a European happy. Confidence in industry has weakened further in the eurozone. In Germany, for example, the purchasing managers' index in manufacturing fell from an already meager 43,2 in July to 42,1. But there was one clear exception. The purchasing managers index for the French services sector made a giant leap: from 50,1 in July to 55,0 in August. One must fear that this leap will be temporary. We'll see.

Wages in Europe
The inflation process has entered a phase where wage growth is the main driver. During her press conferences, ECB President Christine Lagarde has repeatedly referred to a relatively new indicator that the ECB has compiled on the wage increase agreed in new employment contracts. Unfortunately, these are quarterly figures (and not monthly figures) and the series is based on data from a limited number of countries (including the Netherlands from the AWVN). This does not alter the fact that it is taken seriously when making decisions about interest rates. In a sense, this is a 'forward-looking' indicator and when conducting monetary policy, one must look ahead because monetary policy simply operates with time lags.

For a year the agreed wage increase was above 4%, but in the second quarter of this year the figure fell to 3,55%. This implies a significant decrease compared to the first quarter: 4,74%. As the next chart shows, that 3,55% is still well above what was common before the pandemic, but it is certainly moving in the right direction from the ECB's perspective. And remember, we don't have to go back to pre-pandemic levels, when inflation was too low for the ECB's liking.

In our own country, as mentioned, the AWVN publishes such figures. This concerns monthly figures, which are frequently revised, albeit modestly. The picture of wage increases according to the AWVN figures is very similar to the ECB figures, although our level is higher. According to the AWVN figures, wage increases in new collective labor agreements have accelerated in the last two months, i.e. June and July. The graph does not make it clear whether it is a trend break or normal volatility, i.e. noise. We'll see.

The Dutch consumer is not getting any happier. According to Statistics Netherlands, consumer confidence remained unchanged in August: -24, well below the long-term average. Consumers became slightly more gloomy about the overall economic situation and slightly less gloomy about their own financial position. Given the increase in purchasing power and the tight labor market, I would expect a clear improvement in consumer confidence. In line with the gloomy mood, consumer spending is disappointing. Consumers also went on strike during the financial crisis of 2008/2009. Former Prime Minister Rutte then called on households to "spend a little more money". Where is that man when we need him? We miss him already...

Closing
The Fed is going to cut interest rates. A first step will come on September 18. Although there are divisions within the Fed, I suspect that the US central bank will continue at a strong pace after that. This expectation is partly based on the significant downward adjustment of the employment figures in March of this year.

The confidence indices of European purchasing managers continued to decline across a broad front in August. It is doom and gloom, especially in the industry. The purchasing managers index in the French services sector has actually risen sharply, no doubt due to increased activity due to the Olympic Games.

The wage increase, as agreed in new wage agreements in the second quarter in the eurozone, shows a sharp decline. The level is still higher than what is consistent with the ECB's inflation target, but the ECB offices will have reacted with relief. It strengthens the position of those who want to reduce interest rates quickly and preferably significantly.

According to figures from the AWVN, the agreed wage increase in June and July actually accelerated in our country. But maybe that's noise.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.