Viewpoint
September 13, 2024 | 15:42
September 13, 2024
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Interest Rates Have Already Plunged, Now the Fed Needs to Deliver |
| It’s almost game time and the players are already in position. Not for this Sunday’s football game, but for next week’s FOMC decision. The market is already positioned aggressively for a dovish message from Jay Powell and the FOMC next week. That raises the risk in my mind of a hawkish surprise that could whipsaw markets at least temporarily. The Fed funds futures market currently is pricing in between 100 and 125 basis points of Fed rate cuts by year-end and 250 basis point of cuts (the equivalent of 10 quarter point moves) by the end of 2025 (Chart 1). There is little doubt the September FOMC meeting will be one of the most consequential since the Fed started hiking interest rates in March 2022. It could also be a major market mover too if fixed income and equity traders find themselves on the wrong side of that trade. As markets have priced in more and more Fed rate cuts over the next year and a half, both nominal and real Treasury yields have plunged from one month and a year ago (Chart 2). This is already working to loosen financial conditions and support real consumer spending even before the Fed makes its first move. According to data from Bankrate.com, average 30- year mortgage rates have already fallen nearly a percentage point since April from 7.56% to 6.63%. |
| The mixed August inflation data released earlier in the week, coming in slightly on the hotter side of the whisper numbers at least on the monthly core measures (Chart 3), has not settled the debate around a quarter-point or half-point initial cut from the Fed next week. A quarter-point rate cut, as we have been forecasting for some time now, seems to be the safest bet for the day. The fed funds futures market is still pricing in a 48% chance of a bigger half-point cut to kick off this monetary loosening cycle (according to Bloomberg). Yet, the latest labor market and inflation data have done little to illuminate the pace of Fed rate cuts from here. Even if the Fed surprises with a half-point cut, the fixed income market will remain extremely focused on the Fed’s updated 'dot plot' and any clues from the FOMC's Statement and Jay Powell’s press conference that might reveal the tempo of expected rate cuts from here. The Fed’s stale June Summary of Economic Projections (SEP) is getting an update this month. On the Fed’s median economic projections, we expect an upward revision in the Q4 2024 and 2025 unemployment rates and a modest downward revision in their median core PCE inflation projection for 2025. This will pave the way for a migration of the 'dots' lower than what was published back in June. Then, the median forecast was for only one quarter-point rate cut in 2024; we expect the revised dot plot to show three quarter-point cuts by year-end with at least five more in 2025. Will Powell opt to front-load the rate cuts given the level of restrictiveness of current policy and to get ahead of any additional slowing in the labor market? Or will he lean toward a more cautious measured path toward the neutral rate given the elevated housing and services inflation for August and still firm third quarter GDP growth that looks to be coming in at a respectable 2.0% annualized growth rate. Adding to the uncertainty, on Tuesday, the first day of the FOMC meeting, we receive August retail sales and industrial production reports. While one month of production and sales data so close to the decision date will not likely sway many opinions or votes on the Committee, however, you can’t completely discount the possibility of a really bad report getting more attention than normal for a Fed that is this data dependent. For the record, we expect a pull-back in August retail sales of 0.3% on the weakness in motor vehicle and gasoline sales last month, but core retail sales, excluding autos and gas, should continue to climb 0.3%, presenting a muddled picture of the consumer. Industrial production won’t provide a clear signal either as we expect a modest bounce back of 0.1% after July’s 0.6% decline. Evidence perhaps of slowing U.S. GDP growth but not plunging activity. The latter is what would necessitate front loading a strong monetary response that is currently priced into the Treasury yield curve. Does the market know something we don’t? |
Crude Oil Outlook: Reality Bites |
| A new reality appears to have suddenly engulfed the oil market—the outlook for a sustained period of elevated prices has dimmed, at least for the time being. Market participants have been shaken by developments on both the global oil demand and supply fronts; specifically, slowing Chinese demand and OPEC+’s future production strategy. In response, we recently lowered our annual WTI forecast to US$77.5/bbl in 2024 (or ~$75 for the rest of the year) and $77.5 in 2025 (previously $79 and $80 for the calendar years), but risks to these projections remain tilted on the downside. China’s latest trade data have fanned fears that the country’s demand for crude oil—which has been the main incremental driver of global oil demand—is cooling quicker than previously envisioned. Measured in volume terms, imports of crude oil fell a hefty 7.0% y/y in August and are now down 3.1% y/y in the year-to-date. As a result, growth in Chinese oil consumption is now expected to slow significantly, to around 200 kb/d this year, compared to its average increase of 600 kb/d over the past decade. Note that the IEA was originally forecasting an increase of 700 kb/d at the start of the year. Beyond generally weak economic conditions, it appears that the country’s rapid adoption of electric vehicles (accounting for over 50% of new motor vehicles sales) along with the development of high-speed rail networks, is taking a greater toll on both gasoline and jet fuel demand. Nonetheless, we are of the view that the more pressing factor revolves around uncertainty over OPEC+’s production strategy. After all, if not for the fact that the cartel is holding back 5.5 mb/d in output (or 5% of global oil supply), crude oil prices would be much lower. Thus, the big near-term issue facing the cartel is whether it will alter its June decision to gradually unwind the 2.2 mb/d in additional voluntary production cuts. Although OPEC+ decided on September 5 to delay the plan from the start of October to December, it seems quite evident that bringing barrels back online so soon would likely lead to larger supply surpluses based on the cartel’s outlined production targets. This decision to “kick the can down the road” likely explains why market participants remain unnerved. Many were hoping the cartel would reverse the plan to phase out cuts and instead, ideally, commit to taking more production offline. The last two meetings suggest that intra-cartel relations remain intense and complex, perhaps more than what is commonly perceived. This is highlighted by the fact that a significant portion of OPEC+’s total production cuts are voluntary and that many members continue to breach their quotas (e.g., Iraq, Kazakhstan and UAE). Pressure on the cartel is likely to intensify further if crude oil prices continue to struggle before its next meeting. A critical factor that we believe the cartel is wrestling with is its rather optimistic outlook for global oil demand, which it projects to increase by a hefty 2.2 mb/d in 2024, followed by 1.8 mb/d in 2025. In contrast, the IEA is forecasting increases of 900 kb/d in 2024 and 950 kb/d in 2025, in line with the average annual increase of 1.0 mb/d during the previous ten years. Key Takeaway: Although recent history shows that big swings in crude oil prices are not unusual, the prospect for a large, near-term snapback appears challenging at present. Future price developments will depend on whether OPEC+ relents on its decision to unwind its production curbs, in both speed and scale. We think the cartel will ultimately alter its production path, but it will remain a bumpy ride for prices. |
