- Treasuries yields fell throughout July as inflation data showed continued easing and the Federal Reserve moved closer to rate cuts. The US labour market is showing signs of softening, with the US economy adding about 206,000 jobs in June, down from the previous month’s 272,000 jobs. The unemployment rate was at 4.1%. Labour costs are up +4.1% on an annual basis while wages and salaries increased 4.2% on an annual basis, slowing from the first quarter’s 4.4%. Wage growth within a range of 3.0% to 3.5% is generally considered consistent with the Fed's 2% inflation target. Nevertheless, the labour market is cooling. The July JOLTs and ADP reports both indicate that private hiring is slowing: job openings dropped 46,000 to 8.184 million in June. Private payrolls rose by only 122,000 jobs in July after advancing by an upwardly revised 155,000 in June.
- The Conference Board's consumer confidence index rose in July to 100.3 from a downwardly revised 97.8 in June. The Expectations Index, based on consumers’ short-term outlook for income, business, and labor market conditions, was at 78.2 in July, up from 72.8 in June. However, the Present Situation Index, which is based on consumers’ assessment of current business and labour market conditions, declined to 133.6 from 135.3 last month. In addition, the University of Michigan's consumer sentiment index declined for the third consecutive month, reaching 65.6 in June 2024, its lowest level since November, down from 69.1 in May. The current conditions gauge fell to 62.5 from 69.6, and the expectations sub index decreased to 67.6 from 68.8. While year-ahead inflation expectations remained steady at 3.3%, the five-year outlook edged up to 3.1% from 3%.
- The flash Composite PMI Output Index in July was at 55.0, up from June’s 54.8 and a 27-month high. The Flash US Services Business Activity Index for July came in at 56.0, also up from June’s 55.3, a 28-month high. The service sector outperformed manufacturing for a fourth straight month. The Flash US Manufacturing PMI showed that business activity in the manufacturing sector is contracting, as it came in at 49.5, a noticeable drop from June’s 51.6 and a 7-month low. The rate of increase of average prices charged for goods and services continued to slow, dropping to a level consistent with the Fed’s 2% target.
Yield curves
The Fed unanimously voted to keep overnight federal funds rate at the current range of 5.25% to 5.5% at its meeting yesterday. The expectation is that the Fed will cut in September given the more “dovish” tone emerging from Wednesday’s Fed meeting along with comments from Fed Chair Jerome Powell that “A reduction in our policy rate could be on the table as soon as the next meeting in September,” and that that there had been “a real discussion” at the Federal Open Market Committee (FOMC) about cutting rates. Federal Reserve Chair Jerome Powell told reporters on Wednesday that while he viewed the changes in the labour market as "broadly consistent with a normalisation process," policymakers were "closely monitoring to see whether it starts to show signs that it's more than that." Swap traders are pricing in a total of 75 basis points worth of easing this year.
The yield on the 2-year Treasury note, which is highly sensitive to movement of the Fed Funds rate, has fallen from 4.74% in June to 4.36% in July. The benchmark 10-year US Treasury note yield has fallen to 4.035% from June’s 4.56%, while the yield on the 30-year bond had also fallen to 4.35% by the end of July.
Yield swings
US Treasury yields continued to decline in July. Markets have largely priced in a September rate cut and we have started to see a “reversion” of the yield curve since 25th June when it hit its widest since December 2024 at minus 51.6 basis points. This “reversion” indicates that a recession is increasingly unlikely.
Source: Factset
Source: Bloomberg 3:15 PM EDT 1 August 2024
Global Economic and Market Review
In the UK, inflationary pressures continued to subside in June, with the headline rate at 2.0% year-on-year. While core inflation measured 3.5%, services prices remained elevated at 5.7%. Concurrently, unemployment edged up to 4.4% from 4.3%, while the annual growth in total earnings (including bonuses) was 5.7%.
On the growth front the UK continued to surprise. The S&P Global Flash UK PMI Composite Output Index rose to 52.7 in July from 52.3 in June, signalling a solid upturn in private sector activity. The flash Services PMI also rose. It came in at 52.4, up from June’s 52.1 and a 2-month highs. Consumer sentiment is showing signs of improvement, as evidenced by the GfK Consumer Confidence Survey, which indicated a rise in the confidence index to -13 in July, a one point increase from June. Notably, two measures were up, one was down and two were unchanged in comparison to June’s numbers. Retail sales volumes experienced a significant 43% year-on-year drop in July 2024, an even steeper decline than the 24% decrease recorded in June, according to the latest Confederation of British Industry (CBI) Distributive Trades Survey.
The Bank of England (BoE) which had held rates at 5.25% throughout July, cut them by 25 basis points today with BoE Governor Andrew Bailey saying the BoE would move cautiously going forward. The MPC voted 5-4 in favour of a cut to 5%, saying, “Key indicators of inflationary pressures remain elevated, and recent strength and economic activity is added to the risk of more persistent inflationary pressures. And this, of course, gives us pause for thought.” Markets are expecting at least one more rate cut this year. The BoE upgraded its growth forecast to 1.25% from 0.5%, but left projections for 2025 and 2026 unchanged at 1% and 1.25%. However, service sector prices remain high despite falling headline inflation. The BoE also said inflation is likely to rise to 2.7% this year, but that it will fall back to 1.7% after two years and 1.5% after three. In terms of the timing of its next move, the BoE may decide to wait and see what the implications of the expected 30 October budget by the new Labour government may be in relation to potential inflationary actions.
In the eurozone, the unemployment rate remains at 6.40%, but wage pressures persist as a concern. This is notable in light of the euro area's annual inflation rate, which rose to 2.6% in July 2024 from 2.5% in June. Core inflation, which excludes more volatile energy, food, alcohol and tobacco prices, was at 2.9% in July, unchanged from June. On the growth front, the eurozone HCOB flash Composite PMIs for July fell to 50.1 in from 50.9 in June, pointing to a near-stagnation of private sector activity. Output in Germany decreased for the first time in four months, while companies in France reported a third consecutive monthly reduction in business activity while the rest of the euro area grew at the slowest pace since January.
Following on from the ECB’s 25 basis point cut in June and concerns over the slow rate of growth, markets are expecting two additional rate cuts this year. There are rising expectations that the ECB will make a second cut in Septermber as it will have additional inflation and growth data to reflect upon.
The benchmark German 10-year yield was -19.6 bps in July at 2.305%, while the UK 10-year yield was -20.7 bps through July at 3.970%. The spread between US 10-year Treasuries and German Bunds contracted by -17.1 bps from 30th June. It currently stands at 172.3 bps. The gap between Italy and Germany's 10-year yields, a gauge of investor sentiment towards the eurozone's more indebted countries, is, according to Worldgovernmentbond.com, now about down to 137.9 basis points, down from June’s 157 basis point differential.
Global bond markets, although starting to rally at the prospect of more and faster rate cuts, still have to contend with the idea that both Fed and other central banks may have, at least in the medium term, higher neutral rates. In addition markets can still be spooked by rising geopolitical factors. The ongoing war in Ukraine, growing trade fragmentation with potentially deteriorating economic relations with China, and increased risk around the US election, will likely keep bond yields volatile throughout August. We also have the ongoing longer term concerns related to structural demographic shifts affecting labour markets tightness and participation rates, the implications of new US, UK and Europe-wide approaches to migration, and the consequent impact on wages, particularly in the services sector. In addition, as OPEC+ tries to maintain a level of “stability” in the market by shifting supply, this may make energy prices more volatile in the short to medium term.
Given that we are likely to continue to see a steepening in rates as the Fed gets closer to its first rate cut, we then have to consider the potential changes in US election outcomes with the consequent implications for the repricing of government debt and term premia. This will also be the case in the UK and in France. Investors may wish to consider adding tactical exposure through yield-spread targeting.
Key risks
- Inflation fails to fall in line with projections, weighing on asset prices. The divergence in central bank policy rates is changing with the Bank of Japan raising interest rates by 15 basis points on Wednesday while the Bank of England agreed a 25 basis point cut on Thursday. Although inflation is falling in Europe, the UK and the US, it may not fall in line with projections due to sticky services costs, particularly in Europe. There are also risks that headline inflation may rise due to commodity prices rising as global demand increases, particularly for materials used in the electric car industry and if weather conditions earlier in the year and over the summer lead to rising food prices.
- Policymakers are unable to continue to fight inflation while supporting economies. ECB and UK policymakers in particular will need to be cautious about getting the balance between supporting their economies while fighting future inflation risks. In addition, a variation in the timing of rate cuts could cause currency volatility.
- Geopolitical tensions and events. Tensions in the Middle East are rising, with Israel hitting key Hamas targets in Iran and in Lebanon.There is also the continuing war in Ukraine, which may become more complicated if Europe is unable to continue to provide support and the US becomes increasingly isolationist. The tensions in the South China Seas remain as well as the tensions between the US and China in relation to Taiwan.
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