We have added additional rate cuts at the November and January FOMC meetings to our profile. Our unrevised terminal rate of 3.375% is now seen at end-2025 instead of mid-2026.
July’s US employment report unnerved global markets. Growth in nonfarm payrolls slowed to less than half the average of the prior twelve months (including revisions) and the unemployment rate rose by 0.2ppts in the month to 4.3%.
The unemployment rate’s rise held particular significance for many in the market. Firstly, it triggered the Sahm Rule (an indicator that states that a recession has started once the three-month moving average of the unemployment rate is 0.5ppts above the lowest three-month average of the past 12 months). In addition, the July print was 0.1ppt above the peak rate the FOMC foresaw through 2024–2026 at the time of their June meeting.
Fearing the FOMC may have missed their opportunity to produce a soft landing, participants quickly jumped to price in a near 100% chance of a 50bp cut in September and a 60% chance of a follow-up 50bp move in November. Around 110bps of easing is currently expected by end-2024, to be followed by a string of additional cuts in 2025 towards the FOMC’s 2.8% ‘longer run’ estimate.
Westpac has warned throughout 2024 of a coming deterioration in the US labour market, so July’s outcomes are not a big surprise. However, we remain confident in the underlying health of the US economy and believe the FOMC will as well, resulting in a more muted easing cycle than the market currently expects.
In gauging the underlying health of the US economy, firstly it is important to recognise that US employment estimates are, at worst, pointing to a stalling out of job growth, not an outright contraction, with household employment, the weaker of the two key measures, having averaged +19k the past six months.
While the ISM surveys have, over the past six months, signalled the possibility of a dramatic reduction in labour demand, the NFIB small business survey’s employment measure has held modestly above average and the Federal Reserve’s Beige Book is in keeping with the household survey’s signal of ‘only’ a stalling out of employment growth. Hours worked from the establishment survey also continues to track nonfarm payrolls, so there is no evidence of hours being reduced disproportionately either.
Current momentum in US economic activity is also healthy, with domestic final demand growth around average in the first half of 2024, circa 2.5% annualised. Households’ decision to lock in historically low rates before and during the pandemic continues to provide benefit, while consumer wealth and debt levels remain constructive for spending and confidence.
For the FOMC then, as inflation continues to come down and with the labour market weaker today than expected over the forecast period, there is cause to cut decisively into year end and through early-2025. But, given the economy’s resilience and the absence of evidence that inflation will soon undershoot the FOMC’s 2% target, there is no need to rush to neutral or below.
As before, we look for the FOMC to begin the cutting cycle in September with a 25bp cut. In view of the greater downside risks becoming evident in the labour market data, we now also forecast 25bp cuts at the November 2024 and January 2025 meetings in addition to those already expected in December 2024 and March 2025. A cut per quarter from the June quarter will see our unrevised terminal rate of 3.375% reached at end-2025 instead of mid-2026.
We will have more to say on the implications for term interest rates and the Australian dollar in our forthcoming August Market Outlook. But, broadly speaking, while we expect the 10-year to hold near its current level over the remainder of the year as rate cuts commence, it is then anticipated to drift back up to around 4.00% in mid-2025, putting in place a sizeable spread to the fed funds rate.
This will be a consequence of the US economy’s underlying health, but also the established trend for the Federal deficit and evidence of inflation pressures related to capacity constraints and trade policy. While these uncertainties remain, it will prove difficult for the Australian dollar to stage a strong rally, although the recovery in Australian growth in 2025 and improving global sentiment should allow for a slow uptrend through USD0.70 from late-2025.
