ECB Cuts Rate to 3.25%, Signals Growth Concerns as US Data Surges

ECB Cuts Rate to 3.25%, Signals Growth Concerns as US Data Surges 

Yesterday, the European Central Bank (ECB) made an expected move by cutting its deposit facility rate to 3.25%. This decision didn't come as a surprise, as the market had already priced in this outcome through OIS futures. All 65 analysts surveyed by Bloomberg, including our own Bas van Geffen, predicted this 25 basis point cut, which marks the third cut in the ECB's current easing cycle. Now, the futures market is showing 37.7 basis points worth of additional cuts priced in for the ECB's December meeting. ECB President Christine Lagarde raised concerns about the region's growth outlook, particularly in the manufacturing sector, which has been struggling due to rising energy costs, competitive pressures, and weaker growth in key export markets like China.

But manufacturing isn't the only issue that the ECB is facing. Elwin de Groot, the Head of Macro Strategy at Rabo Research, and Senior Economist Maartje Wijffelaars, have pointed to a broader concern that could be described as a 'catching down' effect. This refers to services indicators that appear to be following the downward trend seen in manufacturing. Rabo Research argues that this softening in the services sector is mainly a result of weak consumer demand rather than a direct spillover from the manufacturing downturn. Lagarde confirmed this view, noting that the ECB had been surprised by the weak consumer spending, as it had expected consumer demand to pick up due to brisk wage growth and a continuation of disinflationary pressures.

Despite this weakness in consumer demand, Rabo Research maintains that there are conditions in place for a rebound. They point to the high household savings rate, which is expected to normalize, the steady growth in real wages, and the likelihood of further monetary easing. However, this rebound has yet to materialize, which has resulted in a notable divergence between European and American consumers. This difference was illustrated by the release of the U.S. retail sales report for September, which exceeded expectations. The report confirmed a 0.7% month-on-month increase in control group sales, compared to the previous reading of +0.3%, leading the Atlanta Fed's GDP Nowcast to rise from 3.2% to 3.4%. U.S. initial jobless claims data also beat expectations, coming in at 241,000 versus the consensus estimate of 259,000.

These strong U.S. data points caused the U.S. Treasury curve to bear-steepen, with 2-year Treasury yields rising by 3.2 basis points and 10-year yields climbing by 7.7 basis points. In contrast, the German Bund curve also steepened, but the ECB's dovish message, coupled with a slightly softer-than-expected inflation report earlier in the day, led to short-end yields falling and European stocks rising sharply.

Looking ahead to the U.S. Federal Reserve, Fed-dated OIS now has 42.7 basis points worth of cuts priced in for the two remaining FOMC meetings in 2024. Rabo Research forecasts a 25 basis point cut at each meeting, which is also a widely-held view in the market following the strong forward guidance issued by Fed Chair Jerome Powell during his remarks at the NABE conference in late September. However, the recent run of stronger-than-expected U.S. economic data, combined with comments from Federal Reserve officials like Mary Daly and Raphael Bostic, has led to speculation that the Fed might skip a cut at one of its upcoming meetings, which has lifted the front end of the U.S. yield curve.

As a result of this uncertainty, U.S. equity markets showed mixed results. The S&P 500 ended the day slightly lower, down by just 1 point after initially trading with a firmer tone. The NASDAQ was also broadly unchanged, while the less interest rate-sensitive Dow Jones posted a gain of 0.37%. Bitcoin, on the other hand, fell by 1%. Brent crude oil prices rose modestly, supported by geopolitical developments. In particular, news emerged that Israel had eliminated Yahya Sinwar, a Hamas leader who was behind the October 7 attack. This was followed by an announcement from Hezbollah signaling a "new and escalatory phase" in its confrontation with Israel. In line with rising geopolitical risks, gold prices have surged to a fresh all-time high of $2,693 per ounce.

Shifting back to macroeconomic data, the Australian Bureau of Statistics released its labor market report for September. The Australian labor market has been performing strongly, consistently beating expectations for several months. In September, Australia added 64,100 new jobs, far exceeding the Bloomberg consensus estimate of +25,000. The unemployment rate remained steady at 4.1%, following a downward revision to the August figure. Despite this, the participation rate and the employment-to-population ratio both rose to new highs.

Given this continued strength in the Australian labor market, it's clear that there are no immediate signs of softening that would push the Reserve Bank of Australia (RBA) to consider a near-term rate cut. Rabo Research has maintained a more hawkish outlook than many other analysts, sticking to its forecast that the first rate cut won't come until May next year. Previously, many analysts had been looking at the February RBA meeting as a potential cut date, but OIS futures now suggest only a 67% probability of a 25 basis point cut in February.

These odds could change again depending on the upcoming third-quarter inflation report, which is due to be released in the next couple of weeks. However, there's a chance that inflation might continue to prove resilient, meaning that a rate cut could still be pushed further out into the future.