Dovish Sentiment Helps Bonds Fly
Global bonds have enjoyed the rally so far this week as traders increased expectations for interest rate cuts from major central banks this year, particularly the Fed. This surge in repricing was primarily underpinned by Fed Chair Powell's comments on Monday, where he said the central bank will not wait until inflation hits 2% before cutting interest rates. While Powell refrained from providing a specific timeline for rate cuts, swap traders are now pricing in September as the likely starting point, with strong odds for two additional reductions by year-end. This shift in Fed policy outlook has reverberated across global markets.
We wonder where this overzealous repricing is warranted considering persistent inflation risks and the likelihood of continued expansionary fiscal policies regardless of the election outcome. Both major candidates seem disinclined to address the widening budget deficit in the near term, which could fuel inflationary pressures.
Nevertheless, the ongoing disinflation trend and signs of moderating consumer spending suggest that a rate cut, or two, remain plausible this year. June's retail sales figures, while flat overall, exceeded expectations. The control group's surprising 0.9% increase (against a forecast of 0.2%) indicates that consumer spending, though slowing, still demonstrates resilience sufficient to support economic growth. This nuanced economic picture suggests that while rate cuts are possible, they may not be as imminent or numerous as current market pricing implies.
Interestingly, the IMF yesterday issued a cautionary update in its World Economic Outlook, highlighting cooling inflation in major economies. The organisation believes that this trend poses potential risks to global growth, as interest rates may remain elevated for an extended period.
The IMF's report emphasises stubborn services inflation, primarily driven by rising wages, and notes price pressures from trade and geopolitical tensions, particularly affecting commodities like oil. Despite these concerns, the IMF maintains a relatively optimistic outlook, projecting a "soft landing" for the global economy. It slightly raised its growth forecast for next year to 3.3% whilst keeping this year's projection steady at 3.2%.
IMF Chief Economist Pierre-Olivier Gourinchas warned about weak post-pandemic government balance sheets, making economies vulnerable to shocks. He specifically highlighted concerns about the US' fiscal stance, which continues to increase its debt-to-GDP ratio despite full employment.
The global economic landscape presents a complex interplay of optimism and caution. While market enthusiasm for rate cuts is palpable, driven by the Fed's dovish signals, underlying economic realities suggest a more nuanced outlook. Persistent inflation risks, coupled with expansionary fiscal policies, may temper the pace and extent of monetary easing. The IMF's cautiously optimistic stance, highlighting regional disparities and potential vulnerabilities, further underscores the delicate balance central banks must navigate.
If you would like to receive The Daily Update to your inbox, please email markets@epicip.com or click the link below.