Powell signals possible rate cuts in 2024 amid cooling labor market

Jay Powell emphasizes a dovish Fed focus on employment over rate hikes

by Faruk Imamovic
Powell signals possible rate cuts in 2024 amid cooling labor market
© Getty Images/Bonnie Cash

Main Points

  • By stressing that labor-market conditions have considerably cooled, and by saying that the Fed must now give priority to its maximum employment mandate, Jay Powell confirmed the more 'dovish' disposition at the Fed, which was also evident in the June Minutes.

    That could set the stage for two rate cuts in 2024, if US disinflation trends cooperate.

  • As in France, Germany's political center seems to be thinning out too, especially in the large part of Germany formerly in the East bloc.

    Another adverse political surprise - perhaps coming from the regional election in Thuringia in early September - and the EUR/USD could find itself squarely back in the 1.05-1.08 range again.

  • In Mexico, Banxico's hawks have been "triggered" again by high headline CPI inflation in June.

    We can expect that the Official Overnight Rate will stay high - at or near 11.0% - at least until the 2025 fiscal policy outlook resolved is resolved in late autumn. That's why we've expected USD/MXN to fall back to 11.50 by year-end.

So far this week, stock traders have been willing to ignore or dismiss the downside risks related to evidence of a recent slowdown in economic activity indicators in the US and abroad.

Instead, stock indexes have generally risen on the fresh liquidity that's been driven by the premise that the Fed (and other central banks) will either start or continue to reduce their policy interest rates this year. Indeed, central bank easing often serves as the nexus between the "bad news" of a softer economy and the "good news" of lower discount factors for corporate cash flows that propels stocks higher.

But that nexus can also be broken if the economy sinks too far, and too fast - say, in a recession - in which case prices fall more sharply than costs, and sales volumes decline too, leaving profits much lower suddenly. Traders don't think that adverse scenario is happening yet, or think that the Fed would be alert enough to that scenario as to avert it with lower interest rates if it seemed imminent.

The stock market, in effect, depends on the assumption of Fed vigilance - both ways And certainly, Jay Powell didn't dispel that assumption yesterday in his Senate testimony, which is why stocks are having another good session today.

We won't go through every which way that he stressed that the Fed is now vigilant to the prospect of a slowing economy and the recent dis-inflationary trends in the economy (including, especially, in wages). But the most notable things that he said summed up the case adequately - first, that the data says that labor-market conditions have cooled considerably, and, second, that the Fed's two mandates (i.e., price stability and maximum employment) are equally important goals under the law.

Undoubtedly, Powell was remarking upon the rise of the US's (U-3) unemployment rate - to a level that's above the Fed's end-2024 projection of 4.0% - as a significant trend, even if the level remains low by historic standards.

He may also have been referencing the decline in inflation in unit labor costs (ULC), which has retreated by much more than nominal wage inflation measures. In any case, if there's any doubt about about the Fed's new "two-sided" vigilance, Powell made sure to stress that he's "very much aware" of the two-side risks, now.

He was also reminded of the labor market's cooling by the Senate; one member remarked on how job growth - however strong on the surface - was lopsided toward government jobs, rather than private-sector jobs. If the USD didn't fare worse on Powell's testimony, it's likely because other major CBs continue to sound 'dovish' too, having had some recent evidence in hand to do so.

Notably, Canada employment declined in June, falling by -1.4k vs. the consensus forecast of +25k. That has helped now put CAD OIS at levels consistent with more than two more rate cuts in 2024. In the Euro area, the ECB's Fabio Panetta downplayed still-sticky services inflation yesterday, and the EUR OIS yield curve is strongly leaning toward the prospect of another two cuts of -25bps to the Deposit Rate too.

And overnight, the RNBZ shifted to a more dovish tone by saying that the extent of the Overnight Cash Rate's level of restraint "will be tempered over time consistent with the expected decline in inflation pressures” - a change from May’s statement that “monetary policy needs to remain restrictive".

The BoE has been a relative hold-out, with MPC member Jonathan Haskell saying yesterday that inflation "will remain above target for quite some time". Things could change more quickly in the direction of a lower BoE Bank Rate, however, if UK inflation (on July 17) or wage growth (on July 18) are sufficiently low as to compel the MPC to ease on August 1.

(Currently, the GBP OIS curve implies a roughly 2/3rds probability of a Bank Rate rate cut in August.)

Powell signals possible rate cuts in 2024 amid cooling labor market© Getty Images/Matt Cardy

The regional election in Thuringia (in the former East Germany) set for September 1, is now characterized in the polls as 2-way fight between the populist far-right AfD (Alternative for Germany) and the new "Reason and Justice" Party (BSW) - a left-wing nationalist, populist, Euro-skeptic, and socially conservative party founded in 2024.

As in France, Germany's center (CDU, Socialists) seems to be thinning out, at least in the large swath of Germany that was formerly in the East bloc. Another political surprise in the Euro area, and the EUR/USD could remain squarely back in the 1.05-1.08 range again.

Because there won't be any first-tier US data today, the focus will be instead on the second day of Powell's testimony (to the House's Financial Services Committee) and on other Fed speeches and appearances - e.g., Chicago's Austan Goolsbee (a dove) and the Board's Lisa Cook.

As for the upcoming data, all eyes will be on the US's June CPI report tomorrow. Finally, Mexico's June CPI report from yesterday, where the headline surprised to the upside at 0.38% month-over-month (vs. a consensus projection of 0.29%).

That performance was driven by strong inflation in fruits and vegetables, which were affected in June by adverse weather. Core inflation performance was relatively well-behaved at 0.22% month-over-month, in line with the consensus projection (0.23%).

All in all, core inflation declined to 4.13% year-over-year in June, with services inflation dissipating a bit more to 5.15%. Still, the rise in headline inflation prompted one of the Board's hawks - Jonathan Heath - to say that the rise in headline inflation to 4.98% (and the acceleration in the bi-weekly year-over-year print to 5.17%) was "very concerning".

It's no surprise that with Mexico's headline inflation staying high, Banxico's "hawks" have been "triggered" into an even more hawkish tone. This doesn't ensure that Banxico won't cut its Official Overnight Rate on August 8; after all, the Board is still dominated by 3 (out of 5) centrists and doves, against 2 hawks (including Jonathan Heath).

But it does ensure that Banxico will be exceedingly cautious in its tone, if it does cut, give Heath's influence on the Board. Our view is that with the uncertainty surrounding the 2025 budget-setting process in autumn, with the recent volatility in USD/MXN coming off of the election in June, and with the prospect that high headline inflation will take inflation expectations higher, the Board won't cut the policy rate on August 8.

Indeed, with the policy rate staying high (at 11.0%) at least until the 2025 fiscal policy/budgetary outlook resolved is resolved in late autumn, there's a basis for expecting USD/MXN to fall back to 11.50 at year-end (our projection), as carry-traders are made to feel adequately compensated, again.