Week #38 — Market Update for September 16-20, 2024
Executive Summary
US Stock Market: The US stock market experienced a broad rally, with gains evenly distributed across major indices and market segments, spurred by larger-than-expected monetary easing from the Federal Reserve. A growing consensus suggests that the Fed may successfully achieve a soft landing for the economy. However, skeptics, including JPMorgan Chase CEO Jamie Dimon, remain doubtful that inflation will ease so smoothly. Meanwhile, Goldman Sachs' Scott Rubner expects short-term volatility due to technical factors such as negative market positioning, fund flows, and institutional investors reducing risk ahead of the election, despite the potential for a year-end rally driven by "fear of missing out."
At the same time, Bank of America’s Michael Hartnett, a noted "bear," warns that stocks may be overpricing future Fed easing and forecasting an 18% earnings growth for the S&P 500 by 2025, which could lead to a bubble. He advises investors to hedge against risks by buying bonds and gold.
Cryptocurrencies: Bitcoin reached a three-week high, rising above $63,000 alongside a surge in global equities. Analysts note that attention may soon shift to the broader economic outlook, as correlations between cryptocurrencies and traditional stocks continue to strengthen. Meanwhile, MicroStrategy Inc. raised $1.01 billion through the sale of convertible senior notes to buy more Bitcoin and refinance higher-yielding debt. The company used $458 million of the proceeds to acquire Bitcoin between September 13 and 19, bringing its total holdings to approximately $15.8 billion (252,220 Bitcoin, up from 244,800 the week before). Led by co-founder Michael Saylor, this move reinforces MicroStrategy's strategy of positioning itself as a proxy for crypto investments since its first Bitcoin purchase in 2020.
Global Stock Markets: Global stock markets generally followed the trends of the US market.
Monetary Policy: Market expectations for the Federal Reserve’s actions have shifted. The likelihood of a 50 basis point rate cut in November has risen to 51.4%, up from 27% a week ago. Traders have also adjusted their projections for 2024's monetary easing, lowering the expected year-end rate by 11 basis points.
Bond Market: The US Treasury yield curve has flattened, with 10-year bond yields increasing by 7 basis points to 3.73% and 30-year bond yields rising by 9 basis points to 4.07%.
For comprehensive insights and a deeper understanding, readers are encouraged to refer to the full article.
US Stock Market
The US stock market showed a broad rally, with even movement across major indices and various market segments, buoyed by larger-than-expected monetary easing from the Federal Reserve. A broad consensus has emerged around the Fed's ability to engineer a soft landing for the economy. However, skeptics like JPMorgan Chase CEO Jamie Dimon remain doubtful that inflation will ease so easily. Others, like Goldman Sachs’ Scott Rubner, anticipate short-term volatility due to technical factors, including negative market positioning, fund flows, and pre-election risk reduction by institutional investors ahead of a potential year-end rally driven by "fear of missing out."
Meanwhile, noted "bear" Michael Hartnett from Bank of America warns that stocks are currently pricing in more Fed easing and projecting an 18% earnings growth for the S&P 500 by 2025, which could fuel a bubble. He recommends investors hedge against potential risks by buying bonds and gold.
Bitcoin reached a three-week high alongside a surge in global equities, rising above $63,000. Analysts highlight that attention may soon shift to the broader economic trajectory, as correlations between cryptocurrencies and traditional stocks continue to increase. Meanwhile, MicroStrategy Inc. raised $1.01 billion through the sale of convertible senior notes to purchase more Bitcoin and refinance higher-yielding debt. The company used $458 million of the proceeds to acquire Bitcoin between September 13 and 19, bringing its total holdings to approximately $15.8 billion (252,220 Bitcoin, up from 244,800 a week ago). This move is part of MicroStrategy's strategy, led by co-founder Michael Saylor, which has effectively turned the software firm into a proxy for crypto investments since its first Bitcoin purchase in 2020.
In terms of sector performance, eight out of eleven sectors showed positive dynamics.
The Fear & Greed Index, which measures market sentiment, rose to 63 from 49 a week ago, entering the “greed" zone.
The SPY ETF has seen a strong recovery, once again approaching July’s peak. The ETF is trading above all major SMAs, confirming the ongoing uptrend. However, traders may exercise caution as the price nears overbought territory, with an RSI of 61.70.
Global Markets
Global stock markets generally moved in tandem with the US market.
The ACWX ETF remains in an ascending trend, with the price above the 50-day, 100-day, and 200-day SMAs. The RSI at 58.56 indicates room for further gains, though the recent pullback suggests short-term caution as the price tests resistance near recent highs.
Economic Indicators, Statistics and News
Several important macroeconomic indicators and economic news were published during the week:
Global
US
·????? The Federal Reserve lowered its benchmark interest rate by half a percentage point to a range of 4.75% to 5%, marking its first rate cut in over four years and signaling a shift aimed at bolstering the U.S. labor market. The Federal Open Market Committee (FOMC) voted 11 to 1 in favor of the reduction, with Governor Michelle Bowman dissenting in favor of a smaller, quarter-point cut—the first dissent by a governor since 2005 and the first from any FOMC member since 2022.
In their statement, policymakers indicated that risks to employment and inflation are "roughly balanced." They expressed a strong commitment to supporting maximum employment while bringing inflation back to the target level. The committee noted that inflation "remains somewhat elevated" and that job gains have slowed. They will consider "additional adjustments" to rates based on incoming data, the evolving outlook, and the balance of risks.
Federal Reserve Chair Jerome Powell stated that the decision reflects growing confidence that an appropriate recalibration of policy can maintain strength in the labor market amid moderate growth and inflation moving sustainably down to the 2% target. He cautioned against assuming that this half-point move sets a new pace for future cuts, emphasizing that policy adjustments will be data-dependent.
Powell emphasized that the labor market is "in solid condition" and that the intention of the policy move is to keep it that way. He noted that launching the unwind of the historic tightening campaign with a significant move while the economy is strong would help limit the chances of a downturn. Powell also mentioned that the central bank "might well have" begun cutting interest rates in July if they had received the weak jobs report before that meeting.
Quarterly economic forecasts released after the two-day meeting showed that a narrow majority—10 out of 19 officials—favored lowering rates by at least an additional half-point over the remaining two meetings in 2024. Seven policymakers supported another quarter-point reduction this year, while two opposed any further moves. Investors are now pricing in another 70 basis points of rate reductions at the Fed's November and December meetings, reflecting a more aggressive stance than that of policymakers.
Additionally, the median projection for unemployment at the end of 2024 rose to 4.4% from the 4% forecast in June, indicating a slight increase from the current level of 4.2%. The median forecast for inflation at the end of 2024 declined to 2.3%, and the median projection for economic growth ticked down to 2%. Policymakers still do not anticipate inflation returning to the 2% target until 2026. Additionally, officials raised their projection for the long-run federal funds rate to 2.9% from 2.8%.
Analysts described the rate cut as a "dovish" move, highlighting a significant shift in the Federal Reserve's policy stance since July. They viewed the half-point cut as a proactive measure to support the labor market amid subsiding inflation risks, rather than the start of a trend toward aggressive easing due to economic weakness. Market participants anticipate that stocks may rise as investors digest the news, given the favorable backdrop of a supportive Fed and signs of resilience in U.S. economic growth. However, some analysts cautioned that while markets might expect further significant cuts, the Fed remains data-dependent and may opt for smaller, quarter-point reductions in the future. Analysts also emphasized that the Fed's increased focus on the labor market and acknowledgment of downside risks to payroll growth were key aspects of the policy shift, signaling a greater emphasis on sustaining employment levels.
·????? Both Kamala Harris and Donald Trump have unveiled economic policies that could significantly reshape the U.S. economy and impact financial markets. Harris, positioning herself as a champion of the middle class, has shifted toward moderate, pro-growth stances, reversing some earlier positions. She proposes raising the corporate tax rate from 21% to 28% and increasing taxes on high earners and capital gains, though to a lower rate than previously targeted by President Biden. Her campaign supports nearly all the new taxes in Biden’s latest budget, aiming to generate $5 trillion in new revenue over the next decade. This revenue would come from higher taxes on corporations and billionaires and collecting more Medicare taxes from business owners and high earners. The funds are intended to finance tax cuts and credits for middle- and lower-income families, including an increased child tax credit and expanded credits for new small businesses.
However, her policies are expected to have a negative impact on U.S. equities. Citigroup strategists estimate that Harris's platform could reduce the fair value of U.S. stocks by 4% to 6%, mainly due to the direct implications of higher corporate tax rates. Goldman Sachs projects that Harris’s plans could reduce S&P 500 profits, as increased corporate taxes would diminish company earnings. The Penn Wharton Budget Model estimates that her tax and spending plans would raise the federal deficit by a net $2 trillion over the next 10 years.
Donald Trump, on the other hand, has proposed a series of tax cuts aimed at appealing to various voter groups. He promises to cut the federal corporate tax rate from 21% to 15% and end taxes on tipped income, overtime work, and Social Security retirement benefits. To offset the revenue loss from these tax cuts, Trump pledges to enact a 10% across-the-board tariff on imports and increase duties on Chinese-made goods to 60% or more, claiming this would generate trillions for the U.S. His running mate, Ohio Senator JD Vance, supports this approach, suggesting that penalizing companies for manufacturing overseas would balance out the deficit impact and allow workers to keep more of their money.
Economists argue that the proposed tariffs would not generate sufficient revenue to offset the tax cuts and could have adverse effects on the economy. The Peterson Institute for International Economics calculates that a 10% tariff on all imports, plus 60% on China, could raise approximately $225 billion a year, not accounting for potential trade retaliation. Bloomberg Economics estimates that an across-the-board tariff of 20% could yield between $300 billion and $400 billion annually. These figures fall short compared to Trump's tax and spending promises, which the Penn Wharton Budget Model estimates would add between $5.2 trillion and $6.9 trillion to federal deficits over the next decade. Other specialists estimate that Trump's tax plans could cost up to $10.5 trillion over ten years.
Higher tariffs could lead to increased costs for American consumers and reignite inflation. Harris has portrayed Trump's tariff plans as a "Trump sales tax" on everyday goods, arguing that Americans would ultimately pay higher prices. Tariffs designed to reduce imports would lead to lower customs revenue over time, as decreased trade volumes shrink the tax base. Trading partners may retaliate with their own tariffs, harming U.S. exporters and potentially slowing economic growth. Businesses like Power Curbers, a North Carolina-based manufacturer that derives a quarter of its revenue from overseas, could face tough decisions if retaliatory tariffs impact their growth opportunities.
Citigroup strategists see Trump's policies impacting the fair value of U.S. stocks between 0% and negative 4%, noting that his program would trigger the biggest hit to the U.S. fiscal deficit, which is set to become a major issue moving forward. Goldman Sachs strategists estimate that Trump's planned tax cuts could lift S&P 500 earnings by boosting after-tax profits. BNP Paribas strategists reckon that U.S. import tariffs of 10% globally and 60% on China could hit the S&P 500 between 9% and 12%, depending on how central banks adjust their policies in response to economic conditions.
·????? In August, the United States economy exhibited a blend of positive and cautionary signs across various sectors. Retail sales unexpectedly rose by 0.1% in August, defying economists' expectations of a 0.2% decline and following a revised 1.1% gain in July. This increase was primarily driven by a robust 1.4% gain in e-commerce purchases, offsetting declines in traditional retail categories such as electronics and appliances, clothing, and furniture stores. Out of 13 retail categories, only five posted increases. Excluding autos and gasoline stations, retail sales advanced for the fourth consecutive month. The control group sales—which exclude food services, auto dealers, building materials stores, and gasoline stations and are used to calculate GDP—rose by 0.3% in August, matching economists' estimates. Over the latest three months, control group sales increased at a robust annualized pace of 5.7%, the fastest rate since August 2023.
Wage growth showed signs of acceleration after two years of steady declines. According to data from Indeed Hiring Lab, posted salaries rose by 3.4% in August compared to a year earlier, marking the fourth consecutive month of acceleration. High-income sectors like software development and finance led this growth, even as employers in these industries have reduced hiring. Middle- and low-wage sectors also experienced gains, though more modestly. Nick Bunker, Indeed's North America Economic Research Director, noted that after declining steadily following an early 2022 peak, wage growth stabilized by late spring 2024 and has now modestly re-accelerated. This trend points to a healthy labor market where competition is prompting companies to raise wages to attract talent.
Industrial production rebounded in August with a 0.8% increase, surpassing all estimates in a Bloomberg survey of economists. This rise followed a downwardly revised 0.9% decline in July, which had been affected by Hurricane Beryl-related disruptions, including power outages and temporary closures in Texas. Manufacturing production increased by 0.9%, bolstered by a surge in motor vehicle output. Excluding autos, factory production still rose by 0.3% after two months of declines. Capacity utilization at factories—a measure of how fully firms are using their resources—increased to 77.2% from 76.6%, while the overall industrial utilization rate rose to 78%.
·????? The U.S. housing market shows mixed signals amid anticipated rate cuts. Confidence among U.S. home builders rose in September for the first time in six months, signaling cautious optimism ahead of expected interest rate cuts by the Federal Reserve. The National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index climbed 2 points to 41, matching economists' forecasts and indicating improved sentiment across all regions.
Despite the positive shift in builder sentiment, the housing market is experiencing uneven residential construction activity. In August, U.S. housing starts rebounded after a sharp decline in the previous month. Beginning home construction increased by 9.6% to an annualized rate of 1.36 million units, the fastest pace since April and surpassing economists' median estimate of 1.32 million. Building permits, a gauge of future construction, rose 5% to a 1.48 million annualized rate, while single-family authorizations reached a four-month high. New construction of single-family homes surged nearly 16% to an annualized pace of 992,000 units, marking the first monthly advance since February. However, starts of multifamily projects declined for the first time since May. Builders remain cautious due to an inventory of unsold homes hovering near the highest level since 2008.
Meanwhile, completions of multifamily housing units soared in August to a five-decade high, potentially easing pressure on rents. An annualized 759,000 residential buildings with two or more units were completed—the most since July 1974 and a nearly 39% increase from the previous month. This surge was primarily due to a near doubling of completions in the South to 502,000 units. Over the past 12 months, multifamily completions have also risen substantially in the West and Midwest, reaching the highest levels since the 1980s, while remaining steady in the Northeast. Nancy Vanden Houten, the U.S. lead economist at Oxford Economics, suggested that multifamily completions might be near their peak due to the typical 18-month lag between starts and completions. She noted that the additional supply has eased some pressure on rents, although rent relief has not been uniform across regions.
Despite these developments, sales of existing homes fell in August to a 10-month low due to persistent affordability challenges. Contract closings decreased by 2.5% from the previous month to an annualized rate of 3.86 million units, weaker than economists had forecast. The National Association of Realtors (NAR) reported that first-time buyers made up a record-low share of August purchases. However, NAR Chief Economist Lawrence Yun expressed optimism, stating that the combination of lower mortgage rates and increasing inventory provides an environment conducive to higher sales in the coming months. Resale inventory rose for the eighth consecutive month in August, with the supply of existing homes increasing by 0.7% to 1.35 million units—the highest since October 2020. The median sales price for existing homes increased by 3.1% year-over-year to $416,700, the highest for any August on record according to NAR data. The so-called "lock-in effect," where homeowners with sub-3% mortgage rates are reluctant to sell, has reduced sales by about one million homes annually, according to Yun.
Mortgage rates have continued their decline, hitting the lowest level since early February 2023. The average rate for a 30-year fixed loan dropped to 6.09% from 6.2% the previous week, according to Freddie Mac. The Federal Reserve's recent half-point interest rate cut and signals of further reductions have contributed to lower borrowing costs. While immediate impacts on the housing market may be minimal due to prior market pricing of the Fed's moves, industry experts anticipate increased buyer activity as rates continue to fall.
·????? The Conference Board Leading Economic Index (LEI) for the U.S. decreased by 0.2% in August 2024, bringing the index to 100.2. This decline follows an unrevised 0.6% decrease in July. Over the six-month period from February to August 2024, the LEI fell by 2.3%, which is a slightly smaller decline compared to the 2.7% drop observed in the previous six months from August 2023 to February 2024. According to Justyna Zabinska-La Monica, Senior Manager of Business Cycle Indicators at The Conference Board, August marked the sixth consecutive monthly decline of the LEI, indicating a continued downward trajectory. The erosion was primarily driven by a decrease in new orders, which reached their lowest level since May 2023. Additional factors contributing to the decline included a negative interest rate spread, persistently pessimistic consumer expectations about future business conditions, and lower stock prices following financial market turbulence in early August.
·????? The New York Fed Staff Nowcast model upgraded its US GDP growth forecast for Q3 2024 to 3.01% from 2.57% a week ago following positive surprises from industrial production, housing and construction, and manufacturing survey data. Similarly, the Atlanta Fed's GDPNow revised its estimate upward to 2.9% from 2.5%.
Europe
·????? Germany's economy is teetering on the edge of a recession, with key indicators pointing toward stagnation and potential decline. The Bundesbank, Germany's central bank, reported that the nation's GDP "could stagnate or decline slightly again" in the third quarter of 2024, following a surprise 0.1% contraction in the second quarter. This marks a revision from the bank's earlier expectation in August of a small increase between July and September.
Despite these concerns, the Bundesbank does not foresee a severe economic slump. "A recession in the sense of a significant, broad-based, and long-lasting decline in economic output is currently not expected," the bank stated. However, it acknowledged that the economy is "still navigating choppy waters," citing a "weak start" to the third quarter for manufacturing and construction sectors, alongside disappointing household spending.
Bundesbank President Joachim Nagel expressed diminished hopes for industrial activity picking up in the latter half of the year. "Stagnation might be more or less on the cards for full-year 2024 as well if the latest forecasts by economic research institutes are anything to go by," he noted. In June, the Bundesbank had projected a modest growth of 0.3% for 2024, but new forecasts due in December may adjust this figure.
Analysts surveyed by Bloomberg echo these concerns, predicting that Germany will narrowly avoid a recession but will only resume growth toward the end of the year. They forecast stagnation for the third quarter, a downgrade from the previously anticipated 0.2% growth. GDP is expected to rise by 0.2% in the final quarter, down from an earlier prediction of 0.3%. Martin Belchev, an analyst at FrontierView, cautioned that even with a late-year uptick, "much of it will be cyclical, with downside risks remaining acute."
A significant contributor to Germany's economic woes is the struggling automotive industry, particularly in the electric vehicle (EV) sector. Mercedes-Benz Group AG shares plummeted by the most in four years after a deepening slowdown in China led the luxury automaker to cut its outlook. The company now expects adjusted returns for its main cars unit to be between 7.5% and 8.5%, down from an earlier forecast of up to 11%. Earnings before interest and taxes are projected to be "significantly below" the prior year's level.
The slowdown in China has severely impacted sales of Mercedes' high-end models like the S-Class and Maybach sedans. CEO Ola K?llenius announced plans for a sales offensive in China with new products to counteract the downturn. "China is turning into a nightmare," analysts at Oddo BHF wrote, highlighting the shift of Chinese consumers toward homegrown brands with advanced in-car technology and away from high-margin luxury models.
Other German automakers are facing similar challenges. Volkswagen AG is poised to close domestic factories in Germany for the first time due to lagging demand. BMW AG has cut its full-year earnings guidance, partly because of sluggish EV sales and the downturn in China. Mercedes-Benz is also grappling with declining sales in Europe, with deliveries across the region dropping 13% in August and down 3% in the first eight months of the year.
The broader European automotive industry is struggling with a significant drop in demand for EVs after governments, including Germany's, scaled back financial incentives that made these vehicles more affordable. EV deliveries in Germany fell by a staggering 69% in August, contributing to a 36% decline across the European region, according to the European Automobile Manufacturers' Association.
In response to the industry's challenges, German Economy Minister Robert Habeck has suggested the possibility of additional government support for carmakers. During a visit to Volkswagen's electric-vehicle plant in Emden, Habeck acknowledged that while automakers must address internal issues such as cost structures and legacy challenges, the government has "an obligation to do something to get the market going again." He emphasized the need to "set the right market signals and strengthen them," though he did not specify what form government aid might take.
Habeck is scheduled to hold an industry summit in Berlin to discuss strategies for reviving the automotive sector. "It remains to be seen what further talks will bring," he stated when asked about potential government assistance. The minister also underscored that the automakers bear some responsibility for their current predicament and must undertake necessary internal reforms.
However, despite the current challenges, there are signs of potential recovery on the horizon. The Conference Board LEI for Germany rose by 0.3% in July 2024, reversing the decline seen in June. While the LEI had contracted by 0.2% over the first half of the year, this was a significant improvement compared to the sharper 4.5% decline from July 2023 to January 2024. This positive turn in the index points to growing optimism in certain sectors of the economy, particularly in new orders for investment goods and rising consumer confidence.
Allen Li, Associate Economist at The Conference Board, noted, "July’s Index reading saw further improvements in new orders for investment goods, which weighed on the Index earlier this year, and consumer confidence. If sustained in coming months, it could signal a potential forthcoming recovery in private consumption and the industrial sector."
Although headwinds, such as ongoing weaknesses in residential construction and negative yield spreads, remain a concern, the gradual recovery of the LEI suggests that some of the pressures on Germany's economy could ease in the near term. This slight rebound, though fragile, offers a glimmer of hope for economic stabilization.
·????? France is grappling with a deteriorating budgetary situation, with the public deficit projected to reach 6% of GDP this year unless new measures are implemented to curb spending or increase taxes. This marks a significant worsening from earlier estimates provided to lawmakers, which anticipated a deficit of 5.6% of GDP without additional action.
Prime Minister Michel Barnier has issued a stark warning about the country's finances, stating, "The country’s budgetary situation is very serious." Nearly two weeks after his appointment, Barnier has yet to form a new government capable of addressing the fiscal challenges and reflecting the diverse priorities of a deeply divided lower house of parliament. His efforts to focus on containing debt and promoting greater tax fairness have met resistance, particularly from President Emmanuel Macron’s centrist bloc, which opposes tax increases in line with Macron's stance against raising taxes.
Outgoing Interior Minister Gerald Darmanin emphasized that it would be "out of the question" for the centrist group to join a government that raises taxes. Barnier's conservative Republicans party holds few seats in a parliament split among three major blocs: the leftist New Popular Front alliance, Macron's centrists, and Marine Le Pen's National Rally. To avoid being toppled through no-confidence votes, Barnier must secure cross-party support, but the left has already pledged outright opposition.
The political impasse has delayed critical meetings, including a postponed session with representatives of Macron's group, such as former Prime Minister Gabriel Attal. Barnier is under pressure to finalize his cabinet swiftly to meet deadlines for presenting the 2025 budget. The outgoing government warns that without decisive action to curtail spending, efforts to reduce the deficit will veer off course.
Bank of France Governor Fran?ois Villeroy de Galhau has expressed skepticism about the caretaker administration's plan to reduce the budget deficit within the European Union limit of 3% of GDP by 2027. He deems the target unrealistic and potentially detrimental to economic growth, suggesting instead a new five-year timeline focused mainly on spending cuts but also considering tax increases. "It will be necessary to lift the taboo on raising taxes, without hitting the middle classes and small businesses, if possible," he stated in an interview.
Economic indicators underscore the nation's challenges. The Conference Board LEI for France decreased by 0.1% in July 2024 to 108.9, following a 0.3% decline in June. This marks the thirteenth consecutive month of decline in the LEI. Over the six months between January and July 2024, the LEI contracted by 2.7%, a steeper drop compared to the 2.0% decline in the preceding six months.
According to Allen Li, Associate Economist at The Conference Board, both financial components of the index and those related to industrial production declined. However, positive developments in new unemployment claims and building permits mitigated the overall decrease. Li noted that "the trajectory of the Index continues to warn of headwinds ahead," citing ongoing political uncertainty and mounting fiscal challenges.
The Conference Board projects that France's GDP growth will moderate in the second half of the year, with an expected growth of about 1.0% in 2024. The economic slowdown is attributed to the political deadlock and fiscal issues currently facing the country.
·????? Italian Prime Minister Giorgia Meloni's coalition is facing significant fiscal challenges as it pledges to reduce the country's budget deficit to within the European Union's limit of 3% of GDP by 2026. Following a cabinet meeting in Rome, the government committed to bringing the deficit below this threshold within two years. Full details are expected to be unveiled after the release of revised 2021 economic output data, which is likely to provide a windfall of up to €3 billion ($3.3 billion).
Statistics officials anticipate that the revision will reflect a larger-than-expected rebound from the pandemic, increasing the 2021 GDP measurement by between 0.9% and 1.2%. This adjustment could bring an additional €3 billion to government coffers. A higher baseline GDP, when compared to unchanged borrowing figures, may result in smaller reported deficits in subsequent years, easing the task of meeting EU fiscal requirements.
Despite this potential boost, the windfall is insufficient to resolve Italy's budgetary issues fully. Finance Minister Giancarlo Giorgetti is working on a fiscal package for 2025 worth about €25 billion, highlighting the scale of the fiscal gap. The government faces internal disagreements on how to fund the budget while adhering to costly campaign promises.
Deputy Premier Matteo Salvini, leader of the League party, insists on fulfilling a tax cut that would reduce taxes on wages, costing €10 billion annually—approximately 40% of the 2025 budget. Despite warnings from economists to limit this expense, Salvini declared the government's commitment to the full €10 billion "and more." Meloni has asked ministries to slash expenses for 2025 by at least €2 billion overall, but this amount is less than a fifth of the cost required to implement the proposed tax cuts and other promises.
Additional commitments include aid to families with children to address a declining birth rate and tax breaks for companies that hire mothers and disadvantaged groups. A proposed simplification of tax brackets could further reduce government revenue. Ministers have considered options such as asset sales, intensified cost cuts, and delayed retirement measures to balance the books.
Italy's budget deficit ballooned to 7.2% of GDP last year, partly due to a home-improvement incentive passed by previous governments. While the European Union had suspended its budgetary rules after the COVID-19 pandemic, it is now pressuring Italy to bring its deficit below 3% swiftly. Finance Minister Giorgetti has indicated that achieving this target will require at least two years.
Italy's public debt remains a significant concern, standing well above 130% of GDP and projected to rise in the coming years. Although the anticipated GDP revision may lower the deficit ratio, it does not address the high debt level. Markets have so far given Meloni's government some leeway, with the spread between Italy's 10-year bonds and German bonds—a measure of risk—reaching a two-year low in March.
Meloni's coalition, comprising her Brothers of Italy party, Salvini's League, and the late premier Silvio Berlusconi's Forza Italia, faces internal conflicts over fiscal policy. The League and Forza Italia are adamant about maintaining the wage-tax cut but have not provided clear strategies for funding it. Proposals such as cutting pensions are politically sensitive, especially since older citizens are a reliable voting bloc. Another idea is to tax the profits banks are earning from recent high interest rates, but a similar attempt in 2023 unsettled markets and was ultimately diluted. Antonio Tajani, the new leader of Forza Italia, opposes any such measure.
As the mid-October deadline approaches for submitting the 2025 budget to Brussels, the government must reconcile its ambitious promises with fiscal realities. "The government continues to move ahead with a fiscally prudent and responsible policy," the finance ministry stated. However, the lack of agreed-upon trade-offs within the alliance raises the prospect that Meloni and her partners remain at odds on how to fund the budget.
·????? The Bank of England (BOE) has signaled caution in easing monetary policy, opting to keep its benchmark interest rate steady at 5% rather than proceeding with a second consecutive cut. The Monetary Policy Committee voted 8-1 in favor of maintaining the current rate, a decision that was anticipated by economists and investors. This move strengthened the British pound to its highest level against the U.S. dollar since March 2022.
Governor Andrew Bailey emphasized that while the BOE expects to reduce interest rates gradually over time, any future cuts will depend on continued evidence of easing inflationary pressures. "It's vital that inflation stays low, so we need to be careful not to cut too fast or by too much," Bailey stated. He highlighted persistent risks associated with "elevated" inflation in the services sector and stressed the need for more data before making further adjustments.
Market reactions included a scaling back of expectations for rate cuts later this year. Money markets now anticipate 42 basis points of easing through December, down from 50 basis points before the BOE's decision.
In addition to interest rates, the BOE announced it will maintain its pace of reducing its bond holdings, keeping the planned runoff at ￡100 billion ($133 billion) over the next year as part of its quantitative tightening (QT) program. This decision aligns with market expectations but comes amid an unusually high volume of bond redemptions—￡87 billion over the next 12 months—which limits the scope for active bond sales. As a result, active sales are projected to decrease from around ￡50 billion to ￡13 billion.
·????? In August, UK consumer prices rose by 2.2% compared to the same month last year, matching July's rate and staying just above the BOE's 2% target. This figure aligned with economists' expectations and was below the BOE's forecast of 2.4%. Downward pressures from motor fuels, restaurants, and hotels were offset by an upward push from air fares.
A key concern for the BOE has been services inflation, which increased to 5.6% in August from 5.2% in July. Although this rise was anticipated and is expected to be temporary, it remains below the BOE's August forecast of 5.8%. Analysts suggest that the steady inflation rate strengthens expectations for another interest rate cut by the BOE later this year.
Retail sales volumes in the UK increased by 1.0% in August, surpassing the 0.4% growth predicted by economists and building on a revised gain of 0.7% in July. The Office for National Statistics (ONS) attributed this stronger-than-expected performance to consumers taking advantage of sunny weather and end-of-season promotions, particularly in food and clothing sectors.
Despite positive retail figures, consumer confidence is waning. The GfK consumer confidence index fell by 7 points to minus 20 in September, the largest decline in two and a half years since April 2022. Households expressed a significantly worse outlook for both their personal finances and the broader economy. The major purchase index, indicating consumers' willingness to make significant purchases like furniture or appliances, dropped by 10 points to minus 23. Analysts attribute the decline in confidence to warnings from Prime Minister Keir Starmer about tough fiscal decisions ahead, which may have unsettled consumers. Danni Hewson, Head of Financial Analysis at AJ Bell, remarked, "Labour's warning that things will get worse before they get better has resulted in a bone-deep chill settling into the consumer psyche."
Asia
·????? The Bank of Japan (BOJ) decided to keep its policy rate unchanged at around 0.25%, a move that aligns with expectations but suggests that any immediate tightening of monetary policy is unlikely. The BOJ Governor Kazuo Ueda has indicated a reduced likelihood of an interest rate hike in October, expressing caution due to ongoing concerns over market volatility following July's rate increase.
Ueda noted that the "upside risk to prices does appear to be easing given the recent yen strength," a comment that led to the yen weakening against the dollar during the day. He emphasized the importance of confirming certain factors before making policy decisions, including close monitoring of financial markets and the state of overseas economies. "There's a lack of clarity for the global economy, especially around the U.S. economy," Ueda stated. "Overall, we're not at a stage where we should immediately hike rates even if certainty rises for our outlook."
Market reactions reflected Ueda's cautious stance. Futures contracts for 10-year Japanese government bonds rose, and overnight-indexed swaps indicated a low probability of a rate hike by the BOJ's October meeting. Specifically, swaps suggested only a 30% chance of an increase by the December policy gathering.
Prior to the meeting, about 70% of economists surveyed expected the BOJ to raise borrowing costs again by the end of the year, with some anticipating an early move in October. However, Ueda's remarks have shifted expectations toward a possible rate hike in December or January. Hideo Kumano, an economist at Dai-Ichi Life Research Institute and former BOJ official, commented, "Ueda's remarks take an October rate hike off the table." Chotaro Morita, chief strategist at All Nippon Asset Management Co., added that the timing of the next rate hike will depend on overseas economic conditions, especially in the U.S., potentially delaying the BOJ's policy decisions. Taro Kimura, an economist at Bloomberg Economics, observed, "The Bank of Japan looks set to pause its rate hikes for longer than we thought. An October move had been our baseline. January now looks more likely, though we are reviewing our call."
·????? In August, Japan's exports grew by 5.6% compared to the same month last year, a significant slowdown from the 10.2% increase recorded in July, according to the Ministry of Finance. This figure fell short of economists' consensus estimate of a 10.6% rise and was largely affected by a 9.9% decline in auto exports. Shipments of construction and mining machinery also decreased, contributing to the overall deceleration in export growth.
Imports during the same period rose by 2.3%, significantly below the 15% gain forecasted by economists. Consequently, the trade deficit widened to ￥695.3 billion ($4.9 billion). The weaker export figures were partly attributed to the impact of a typhoon that led companies like Toyota Motor Corp. to suspend production at certain factories. Despite the disappointing data, some analysts believe this may not indicate a sustained downward trend. Kazuma Kishikawa, an economist at Daiwa Institute of Research, noted that it's challenging to conclude that exports are losing momentum due to these special factors.
In contrast to the slowing export growth, Japan's key inflation gauge accelerated for the fourth consecutive month in August. Consumer prices excluding fresh food increased by 2.8% year-on-year, up from a 2.7% rise in July, as reported by the Ministry of Internal Affairs. This uptick was driven by higher costs of processed foods and matched economists' consensus estimates. A more refined measure of inflation that excludes both fresh food and energy costs showed a 2% increase, accelerating from 1.9% in the previous month.
Service prices, closely watched by the BOJ as an indicator of underlying price trends, rose by 1.4% from a year earlier, maintaining the same pace as in July. Economists suggest that the consistent increase in inflation may strengthen the BOJ's confidence in achieving its 2% price stability target. Yuichi Kodama, an economist at Meiji Yasuda Research Institute, stated that prices remain relatively stable, and an additional interest rate hike within the year is still possible. Taro Kimura, an economist at Bloomberg Economics, echoed this sentiment, noting that the inflation run-up is likely bolstering underlying price trends, supported by stronger wage growth.
Foreign Exchange Markets
The Dollar Index, which reflects the value of the US dollar against a basket of major currencies, lost 0.4% over the week.
Commodities and Energy Markets
In the commodities sector, most assets ended the week with positive movements.
Debt and Fixed Income Markets
Market Movements
According to CME data, the implied Fed Funds rate curve for the next 18 months (until February 2026) has shown minimal movement.
The US Treasury yield curve flattened, with 10-year bond yields increasing by 7 basis points to 3.73% and 30-year bond yields rising by 9 basis points to 4.07%.
Central Bank Insights
·????? The European Central Bank is navigating a complex economic landscape marked by volatile inflation and uncertainties in monetary policy transmission. President Christine Lagarde emphasized the need for the ECB to carefully consider how it manages risks and uncertainties in an era shaped by the pandemic, the war in Ukraine, and the energy crisis. These events have altered the economic structure, making it challenging to assess the impact of monetary policy. Lagarde indicated that inflation is projected to return to the ECB's 2% target over the second half of 2025 but stressed that the uncertainty ahead remains profound due to transformational changes in the economy.
Bundesbank President Joachim Nagel echoed the need for vigilance, stating that while consumer price growth is on track to slow to 2% by the end of next year, policymakers must remain alert. He noted that inflation has been a "greedy beast" in the past and, despite recent progress, the ECB is "not yet there" in achieving its goal. Nagel highlighted that the disinflation process is tenacious, partly because wage growth eases slowly. He mentioned that wage compensation per employee has been growing at a rate of over 4%, and price pressures in the services sector remain alarmingly high.
Governing Council member Pierre Wunsch expressed that the ECB should be able to continue easing policy but must be cautious due to persistent inflation in the services sector, which remains high at about 4%. He pointed out that while consumer price growth appears to be under control, services inflation could cause the easing process to happen more slowly than anticipated, especially if the economic recovery gains momentum and inflation stays above 2% for a longer period.
Peter Kazimir, another Governing Council member, suggested that the ECB will likely wait until its final meeting of the year in December to consider lowering interest rates again. He believes the likelihood of an October rate cut is very small, requiring a significant shift or powerful signal concerning the economic outlook to support another reduction. Kazimir noted that inflation, particularly in the services sector, is still persistent and that the economic recovery has been disappointingly weak. He cautioned that lowering rates is not a magic fix for Europe's deeper economic challenges.
Chief Economist Philip Lane reinforced the cautious stance on lowering interest rates, emphasizing the importance of a meeting-by-meeting approach contingent on incoming data. He stated that a gradual approach to dialing back restrictiveness is appropriate if the data align with baseline projections. Lane mentioned that headline inflation is expected to fluctuate in the coming months, likely to be low in September before rising again later in the year. He also noted that negotiated wage growth will remain high and volatile due to one-off payments in some countries and the staggered nature of wage adjustments.
Martins Kazaks, a Governing Council member, indicated that while the ECB will ease monetary policy further, it should not act hastily due to lingering inflation risks. He observed that interest rates remain "pretty restrictive" and that the pace of future cuts will depend on services inflation and the prospects for Europe's stuttering economy. Kazaks referenced market expectations that rates could be around 2.5% by the middle of next year.
Gediminas Simkus, also on the Governing Council, stated that there is little chance of an interest rate cut in October. He believes the euro-area economy is developing according to forecasts and questions the need for an immediate reduction, reinforcing the notion that the likelihood of an October rate cut is very small.
Francois Villeroy de Galhau, Governor of the Bank of France, asserted that the ECB should continue to lower rates as inflation is set to return durably to 2% next year. He acknowledged upcoming volatility in price data but declared that victory over inflation is within sight. Villeroy did not specify the timing of future moves but emphasized the need for a gradual loosening of monetary policy.
Governing Council member Mario Centeno suggested that the ECB may need to quicken the pace of lowering interest rates to prevent inflation from falling short of forecasts. He highlighted the importance of minimizing the risk of undershooting the inflation target, implying that a more proactive approach might be necessary.
Olli Rehn, another member of the Governing Council, stated that the ECB is clearly on an easing path for its monetary policy, with the pace and scope dependent on fresh economic data and analysis. He remarked that the ECB has progressed well in reaching its inflation target and noted downside risks to the economic outlook, which was a factor in the recent decision to cut rates.
Vice President Luis de Guindos mentioned that while the ECB will have more information on the state of the economy and inflation at its December meeting, it has left the door open for potential action in October. He highlighted that consumer price growth has been slowing, but services inflation remains the "weak spot" due to elevated wage dynamics, with compensation per employee growing at over 4%. De Guindos pointed out that September inflation data is expected to look very positive due to base effects, but inflation may rise again in the last quarter of the year for the same reason.
Overall, the ECB's policymakers underscore a cautious yet flexible approach to monetary policy easing. While there is a consensus that interest rates will continue to be lowered to support economic recovery and achieve the 2% inflation target, concerns about persistent inflation in the services sector and elevated wage growth are prompting a more measured pace. The timing of future rate cuts remains uncertain, with many officials pointing to December as a more likely period for action, contingent on incoming economic data and inflation trends.
·????? Bank of England policymaker Catherine Mann has expressed a preference for maintaining higher interest rates for a longer period before considering more aggressive cuts once inflation risks have clearly subsided. Mann, known as the most hawkish member of the BOE's Monetary Policy Committee (MPC), outlined her stance during a speech at a conference in Lithuania.
She highlighted that market expectations of the U.S. Federal Reserve rapidly reducing interest rates have significant spillover effects on the United Kingdom. These expectations are a "material input" to her cautious approach toward easing monetary policy. Mann warned that premature rate cuts could undermine efforts to control inflation, especially given ongoing concerns about elevated wage growth and persistent services prices in the UK.
While headline inflation is close to the BOE's 2% target, Mann emphasized the importance of remaining vigilant. "A risk management assessment implies that it is better, under inflation uncertainty, to remain restrictive for longer until right-tail risks to the inflation process dissipate, and then to cut more aggressively," she stated.
Mann explained her decision to support holding rates steady in September, despite having opposed the earlier rate cut. She considered the mounting pressures on consumers from housing costs and contemplated supporting a reduction last month. However, she decided against it to avoid a "boogie-dance" with rates—referring to frequent and potentially destabilizing shifts in monetary policy.
She also expressed concerns that structural factors, such as wage negotiations, product pricing, and international economic conditions, could hinder the BOE's ability to maintain low inflation without a prolonged restrictive monetary stance. "As a small open economy, the macroeconomic and monetary conditions of the UK's largest trading partners matter significantly for the domestic outlook," Mann noted.
·????? In recent discussions surrounding U.S. monetary policy, two prominent Federal Reserve Governors, Christopher Waller and Michelle Bowman, shared their perspectives on inflation and interest rate adjustments, reflecting slightly divergent views on the best course of action to tackle inflation and manage economic growth.
Federal Reserve Governor Christopher Waller expressed his support for the recent decision to lower interest rates by half a percentage point, attributing this stance to softer-than-expected inflation data rather than concerns over the labor market. Waller noted that the Fed's preferred inflation measure, the personal consumption expenditures (PCE) price index, had risen at an annualized rate of less than 1.8% over the last three months, below the Fed’s 2% target. He suggested that if the economy continues to evolve as expected, he would support quarter-point interest rate cuts at the next two Federal Reserve policy meetings in November and December. However, Waller also cautioned that the trajectory of future rate cuts could change depending on economic data, such as worsening labor market conditions or a further slowdown in inflation. Conversely, if inflation were to pick up again, the Fed might pause these cuts.
On the other hand, Federal Reserve Governor Michelle Bowman took a more cautious approach to the rate cut, voicing concerns that the half-point reduction in interest rates could be misinterpreted as a premature signal that the Fed had already won its battle against inflation. Bowman stressed that moving too quickly could undermine progress toward price stability and that the Fed should aim for a more neutral policy stance by proceeding at a measured pace. She pointed out that inflation is still above the Fed’s 2% target, with core PCE prices rising more than 2.5% annually. Bowman highlighted her concerns about strong consumer spending and robust demand, driven by a healthy labor market, which could continue to exert upward pressure on prices.
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