Week ahead: China’s surprise rate cut, and the Fed’s dovish pivot faces key test

Asian stocks have been given a boost at the start of the week after China cut one of its main short term interest rates overnight. The 14-day reverse repo rate was cut to 1.85% from 1.95%. Although small, this cut has helped to push European equity futures into the green at the start of the week, after a sell-off on Friday. It also boosted the oil price, which is back above $74 per barrel. The price of gold also hit another record above $2,630.

HSBC suffers from Hong Kong’s property woes

The cut to China’s interest rate could also boost HSBC’s share price. The UK bank has been hit hard by the decline in Hong Kong’s commercial property sector. The bank announced that it has a $3bn exposure to defaulted commercial real estate property loans in Hong Kong, and it highlights how China’s well-known property woes are spreading to Hong Kong. The extent of the issue facing Hong Kong is stark. Prime office rents have fallen 35% since 2020. Although some of the defaulted loans are due to Loan-to Value ratios falling below certain thresholds, HSBC has also seen an uptick in HK borrowers asking for deferred payments. The rate cut is small and may not be enough to spur a turnaround in Hong Kong’s property market, but it is a start. Combined with a briefing on the economy that is expected on Tuesday, the market may see this as the start of a turnaround for the Chinese and Hong Kong economies. However, HSBC saw a massive jump in selling pressure on Friday, and the share price fell 1.3%. The Chinese government will need to offer something big to spur an interest in investing in the country, and stocks associated with it.  

The 50-basis point rate cut from the Federal Reserve was a risky move in case it caused alarm amongst investors. However, far from causing alarm, stocks and commodities rallied and the US yield curve steepened. The US yield curve is now at its highest level since July 2022, which is a sign that investors are confident in the US economy’s growth prospects. The Fed’s rate cut is seen as increasing the chance of a soft economic landing, which is why the S&P 500 soared to a fresh record high on Thursday and closed the week above 5,700.

This is the 39th record close of the year so far. The gains in stock markets faded at the end of last week, however, that was most likely due to profit-taking. Europe sold off more sharply than the US indices. For example, the Eurostoxx index fell 1.5% on Friday, and the FTSE 100 was down 1.2%. Europe under-performed US stocks last week. This is to be expected. Although European and UK shares are considered to be better value than their US counterparts, the growth outlook in Europe and the UK is worrisome. Growth is a key theme for stock markets right now. If the US is expected to have a softer economic landing than Europe, that is where the money will flow, even if some US stocks look overvalued.

The US mid-cap rally could be at risk if cracks appear in the US growth story

The Fed may have bolstered the US growth outlook; however, investors are still employing some caution. For example, the mid-cap Russell 2000 index failed to make a record high last week, although it is only 30 points away from the high reached in July. While US mid-cap shares performed at roughly the same level as big cap stocks last week, the Russell 2000 sold off more sharply than the S&P 500 on Friday. Although the Fed rate cut increases the chance of a soft landing, it does not guarantee it. Stocks that are closely linked to the economic cycle like US mid-caps that are hovering near record highs, may find that there is little margin for error in the weeks to come.

Valuations are also a concern for investors, the S&P 500 is trading with a P/E ratio of more than 24, will investors really want to continue to buy at these valuations? Added to this, there is a lot resting on the incoming economic data. The Fed said that it was still taking each decision meeting by meeting, and they would not pre-commit to rate cuts. This week the focus is on US housing data and the core PCE inflation report for August. Housing is one to watch. Last week, the 10-year Treasury yield rose by 15 basis points, and currently stands at 3.74%. This could put upward pressure on US mortgage rates down the line, so the Fed’s rate cutting cycle may end up weakening the US housing market.

Will housing data flash warning signals about the US economy?

New home sales and pending home sales are released this week, as well house price data for July. House prices are expected to inch up in July, however the annual rate of house price growth could decline slightly to 6.1% from 6.47% in June. The more worrying data is home sales. New home sales are expected to decline by 6% for August, compared to July. Part of this decline is seasonal, but it may ring alarm bells about the health of the US economy. Housing is a cyclical industry, so if it is showing signs of strain, it might be a warning sign that problems in the US economy could be starting to build. Pending home sales are also expected to decline by 0.8% last month. Pending home sales have declined sharply in recent years, mostly due to tight supply. Added to this, some buyers may put off buying a home due to expectations that the Fed will cut rates sharply in the coming months. This could put pressure on home sales for some time. Thus, we think that new home sales is a more important gauge of the state of the US housing market right now. It is worth noting that home builders have built up a large inventory of homes for sale, thus we could see a mixture of incentives and price cuts enticing buyers back to the market in the coming months.

Also worth watching in the US this week will be the Richmond Fed manufacturing index and the provisional S&P global manufacturing and service sector PMIs for September. Expectations are for service sector data to remain strong, but for manufacturing activity to register another month in contraction territory. However, on a positive note, the pace of decline is expected to slow compared to August’s reading.

Will the Core PCE report challenge the Fed’s credibility?

The other key data release for the US is Friday’s personal income and spending data, along with the core PCE reading for August, the Fed’s preferred inflation measure. Personal income is expected to have edged up last month to 0.4% from 0.3%, while real personal spending (adjusted for inflation) is expected to have moderated to 0.1%, down from a 0.4% rate in July. If correct, this would be the slowest pace of spending growth since April. The core PCE report for August is one of the most crucial pieces of data since last week’s Fed meeting. It is expected to rise at a 0.2% monthly rate; however, the annual rate is expected to tick up to 2.7% from 2.6%. While a small fluctuation is unlikely to knock the Fed from its rate-cutting course, a 2.7% YoY rate is higher than the Fed’s 2.6% projection for core PCE for this year. Thus, inflation needs to start falling in the US, otherwise the Fed’s credibility could be at risk.

The Dollar outlook

The market is likely to be reactionary to the PCE data and signs that the US housing market is not experiencing the ‘soft landing’ that the Fed is aiming for. Any weak spots in this week’s data could lead to a souring of risk sentiment and a bounce in the dollar. The dollar was mixed last week. It managed to make a decent gain vs, the yen and the Swissie, however, it sold off vs. the euro and the pound. The bounce in USD/JPY was also linked to the BOJ, who did not signal further rate hikes at its meeting last week. It’s worth watching to see if the bounce in long term US yields also adds support to the dollar in the coming weeks. The dollar index has fallen more than 5% since July and is testing a key support zone around the 100.00 level. If it breaches this key level then expect more widespread dollar declines, however, if the dollar index can hold above this level, then it could be a sign that the dollar will experience a period of stabilization as we move towards Q4.

European PMIs to be weighed down by Germany

Elsewhere, Europe faces a key test this week, with important data releases for Germany and the first reading of September’s PMI reports. The PMI readings could give us a clue about what to expect for Q3 GDP. The composite PMI report for the Eurozone is expected to decline to 50.5 from 51.0. There is a large dichotomy in the performance of the service and manufacturing sectors in Europe. The service sector PMI is expected to fall slightly to 52.3 from 52.9 in August, however, the manufacturing sector is expected to slip deeper into contraction territory at 45.7. The average composite PMI reading for July and August is 50.6, which is lower than the average readings for April – June, thus growth in Q3 could slow compared to Q2’s 0.2% rate. As mentioned above, growth expectations could hinder the performance of Europe’s stock market vs. the US. On a YTD basis, the Eurostoxx 50 index is higher by 7%, which is a decent return, however, the S&P 500 and the Nasdaq are both higher by nearly a fifth so far this year. The difference between the performance of the blue-chip US and European stock indices is stark. Combined with a central bank that is chasing growth, and not worrying about inflation, the short-term outlook for US indices remains stronger than for European indices, in our view.

Why the DAX is not feeling the German economic woes

Economic data in Germany will also be watched closely. Investor confidence has fallen sharply in recent months, as the manufacturing sector lurches from crisis to crisis and news in the corporate sector remains concerning. Commerzbank might be taken over by UniCredit, BMW and Volkswagen are both suffering, and Mercedez Benz said last week that its sales are suffering from a slump in Chinese demand and weak demand for its EVs at home. Its stock was one of the weakest performers on the Dax index at the end of last week, and its stock price fell by more than 6% on Friday. Its share price is down nearly 10% in the past month. BMW’s stock price is also down more than 10% in the past 4 weeks, and VW’s share price has fallen by 5%.

The IFO could tell us if a recession is on the cards for Germany

The German IFO is worth watching closely to see if there is an end in sight for the misery in the manufacturing sector. The IFO is a reliable early economic indicator for Germany, however, the news is not good. Economists expect both the current conditions survey and the expectations reading to decline further in September. This would be the fourth consecutive monthly decline, and it would increase the chance of a third quarter negative growth rate for the Eurozone’s largest economy. However, bad economic news does not have to weigh on the Dax index. The Dax is an international stock index, and while some sectors are experiencing issues like finance and the car sector, it continues to remain resilient to domestic troubles. The index hit another record high on Thursday and is likely to follow US indices closely. The French index is also worth watching on Monday. Will it open lower after the newly formed government suggested that some business taxes would have to rise on the back of a deteriorating picture for French debt?

UK PMI data to continue to outperform Europe and US

It’s a much quieter week for the UK, after last week’s BOE decision. The September PMIs are expected to continue to outperform the US and Europe. The composite index is expected to decline slightly to 53.5 from 53.8. The manufacturing sector is expected to come in at 52.2 and the service sector survey is expected to be 53.5. This suggests a resiliency in the UK economy. However, hard economic data, for example recent monthly GDP reports, have been disappointing. If there is an upside surprise in the PMI reports, it may suggest that growth in the third quarter could surprise us.

Will Labour change its tone on the economy?

Also worth watching this week is the Labour Party conference. Look out for an update on potential tax changes in the Budget in October. Also worth watching is how the Chancellor will react to the news that the UK’s debt to GDP ratio has hit 100% of GDP. If Reeves wants to stick to her own rules, she either needs to recalculate how UK debt is measured (by excluding BOE transfers) or she needs to reiterate her message that taxes will rise, and spending will have to come down. The latter message is likely to knock consumer confidence even more. As we have mentioned recently, the risk is that the UK economy thinks itself into a recession. The UK desperately needs an economic plan, and investors will want to see what shape it could take at this week’s conference. If there are growth gaps, then the pound could come under pressure this week.

Rightmove rejects £5.9bn bid  

It's also worth watching Rightmove at the start of this week. The online property portal is expected to formally reject an improved offer from REA group. It is unknown if REA will continue to bid for the company since it has already revised one offer higher. The Rightmove share price is up by more than 20% on the back of the REA offer, so there could be some volatility in the share price on the back of this news.