Week ahead: Central banks to drive market sentiment, as Trump survives another assassination attempt

US stock markets had their best week of the year last week, the S&P 500 rose more than 4%, the Nasdaq was higher by nearly 6%. US stocks were led higher by tech, Nvidia rose more than 13% last week, although it faded on Friday. The overall driver of the rally was growing speculation that the Federal Reserve will cut interest rates by 50 basis points rather than 25bps when they meet this Wednesday. The probability of a 50bp rate cut has risen sharply and is now 59%, according to the CME’s Fedwatch tool, this is up from 30% a week ago. As we get closer to the FOMC meeting, it feels like this could be epoch changing. The question is, how will markets react?

The case builds for a 50bp rate cut from the Fed

The case for a 50bp rate cut boils down to two things: first, the economic conditions and second, the risk of the Fed falling behind the curve. The economic data is getting weak in the US. The Citi economic surprise index for the US is close to its lowest level since 2015, the labour market is cooling and there are signs of distress in the manufacturing sector, which has been languishing in contraction territory since April. The Fed’s preferred measure of inflation, the core PCE index, has fallen from 5% in 2023 to 2.6% now, which is close enough to the Fed’s 2% target rate. An article in the Wall Street Journal on Thursday spurred speculation that the Fed may start big with its rate cutting cycle. It argued that a key consideration at the Fed is falling behind the curve and letting a soft-landing slip through its grasp. The unemployment rate might be ticking higher, but at 4.2% it is hardly in recession territory. Likewise, the latest GDP estimate from the Atlanta Fed’s GDPNow tool, is predicting growth of 2.5% annualized for Q3, which would be the envy of Europe. There is an argument that why would the Fed risk a rapid rise in the unemployment rate by taking its time cutting interest rates?

Terminal rate expectations

Whether or not the Fed cuts rates by 25bps or 50bps the market reaction will depend on two things: how they communicate the cut and their reasons for cutting by 50bps, and also the Dot Plot and what it tells us about Fed members’ current expectations for the terminal rate. If the Fed does start by cutting 50bps, but at the same time reiterates that it is doing so to preserve the economy’s soft landing, this is stock market positive. If it sounds like the Fed has to panic-cut interest rates because of some grey cloud on the horizon, then expect stocks to sell off. In the last Dot Plot in June, the median projection for longer term interest rates was 2.75%. Watch for any changes in this rate. A lower terminal rate is likely to be good news for economic growth down the line, and it benefits real estate stocks and tech stocks, but it may also be bad for financials, as it would erode net interest income margins in the future. However, if the Fed talks up the soft-landing theory, then longer term rates may not fall as much as expected. An upward shift in the terminal rate, to 3% or above, may also knock risk sentiment and cause stocks to sell off, although we think defensive stocks and financials may outperform.

Stock market outlook

The market rally last week was broad based, and in the last month, the equal-weighted S&P 500 outperformed the market cap weighted index. The top performing sectors last week included semiconductors, broadline retail, and food retail. Unsurprisingly, the oil and gas sector, along with banks, were the weakest sectors on the S&P 500. As we start a new week, US stock futures have opened mostly unchanged, and we expect markets to remain fairly quiet as we lead up to the FOMC meeting.

Unintended consequences

Another reason why the FOMC might choose to cut rates by 50 bps at this meeting is because of the US debt ceiling. If a new debt extension deal is not agreed by 30th September, then the Federal government will shut down.  A stop gap funding bill has been pulled by a senior US House Republican, who has also demanded a concession on voter ID requirements in return for discussing the debt ceiling. A government shutdown on 30th Sept could make it hard for the Federal Reserve to cut rates in November. The reason is that it is unlikely that the Bureau of Labor Statistics would be able to compile key economic data releases in time for that meeting, including the September CPI report and October payrolls. Thus, the Fed may want to get ahead of any political turmoil in Washington by cutting rates by 50bps on Wednesday.

The prospect of a government shutdown does not seem to have registered with investors. However, throwing a government shutdown into the mix with a Presidential election around the corner and the Fed about to embark on a rate cutting cycle, could make for a volatile Q4.

Donald Trump is targeted by assassin for a second time

The other political consideration is the apparent assassination attempt on Donald Trump in Florida at the weekend. The President was unhurt, and it happened at his Florida golf course rather than at a campaign rally. However, it is extremely rare for a US Presidential candidate to be actively targeted by an assassin twice on the campaign trail. The latest FiveThirtyEight poll shows Kamala Harris in the lead by 2.6%. The polls have narrowed in recent weeks, and Harris did not receive much of a bounce even though she was considered the winner in last week’s debate. After the first assassination attempt, Trump saw a large jump in support for him to become President. We will watch to see if the same happens this time.

Bitcoin falls after Trump assassination attempt

In the aftermath of the shooting, the price of Bitcoin has plunged by more than $1,100. Usually when Trump sees a boost to his polling numbers, the price of Bitcoin rises since Trump has pledged his support for the crypto currency. Perhaps the market is weighing up what repeated assassination attempts means for the former President’s safety, which could dent his chances of becoming president once more.

BoE and BoJ watch

The FOMC is the main event next week, however, there is a huge amount of economic data to digest and also central bank meetings taking place across the world. In the UK, economic data this week may complicate things at the BOE. CPI for August is released on Wednesday. The market is expecting headline inflation to remain steady at 2.2% YoY, core price growth, however, is expected to tick up to 3.5% from 3.3%. Service price inflation is expected to rise to 5.6% from 5.2%, which could lead to fears that inflation is raising its head once more. There are multiple factors that could be feeding inflation, a strong consumer, public sector wage increases, UK 3-month annualized wage growth is still 4%. Added to this, the recent cut in interest rates has lifted house prices. According to Rightmove, prices rose by 0.8% so far this month, and 1.2% YoY. Thus, the impact of a small rate cut at the BOE seems to be an effective stimulant for the UK housing market.

Are stagflation risks building for the UK economy?

If estimates are correct and core inflation rises in August, then it seems natural to expect the BOE to pause its rate cutting cycle at this Thursday’s meeting. However, GDP data last week suggests that the UK economy is flatlining. If inflation is rising at the same time, then stagflation comes into view, which could make it even harder for the BOE going forward. This meeting will include the Monetary Policy summary and minutes of the latest meeting, but it will not include a press conference with Andrew Bailey. Thus, the statement will be pored over to see how the BOE could react to rising inflation, especially since price stability if the BOE’s chief mandate. Currently there are approx. 50bps of tightening priced in by the market, if this changes then it may move financial markets.

A rate cut could surprise GBP

The market is still not expecting a rate cut from the BOE this week, there is only a 26% chance of a cut priced in by the options market. The pound is rising as we start the week, after being in the middle of the pack last week. GBP/USD has lost some momentum, which means that the outcome of this week’s central bank meetings will be key. The Fed is still the most important central bank for the currency market. Thus, if the Fed does cut rates by 50bps and keeps its expectation for the terminal rate around 2.75%, the dollar may sell off. Even though the Fed is the king of the FX world, a BOE cut could surprise the market. It would likely weigh on sterling and UK banking stocks.

Will they/ won’t they at the Bank of Japan

Soon after the Fed rate decision, the BOJ will announce its latest policy decision. Economists do not think that the BOJ will cut rates at this meeting, and the futures market is only pricing in a very small chance of a rate cut. BOJ officials have sounded hawkish in recent weeks, and we think that the BOJ will maintain its bias to normalize interest rates in the coming months.

This could be bolstered by an increase in national inflation last month. The August report is expected to show that headline prices rose to 3% YoY from 2.8% in July. The core rate of national inflation is also expected to tick up slightly to 2% from 1.9%. Overall, we think that even though inflation is moving in the wrong direction, it is not doing so at a fast enough pace to make a rate hike from the BOJ this week a priority.

The FX market seems to be ignoring other central banks and focusing solely on the Fed. USD/JPY is lower once more at the start of the new trading week and it’s back at its lowest level in over a year, as the dollar struggles to gain momentum in the lead up to the Fed meeting and in the aftermath of the Trump assassination attempt.