Election Overshadows Fed's Rate Cut
- US: Elections Give Directional Clarity but Magnitude, Timing, Still Uncertain
- UK: Are BoE Projections Too Optimistic?
- RBA: An Outlier
- Spotlight on Next Week
Weekly Highlights
Widely anticipated
Solid but somewhat volatile
Unit labor costs revised up
25-bp cut was expected
Hit by budget uncertainty
Labor demand remains weak
Elevated, but needs more
Worse than expected.
Treading water
US: Elections Give Directional Clarity but Magnitude, Timing, Still Uncertain
It is rare that a Fed meeting is not the main event during the week of its occurrence. But, when competing with general elections—as it did this round—there is no contest. So, the Fed’s well-anticipated 25-basis point cut had little impact on markets.
The big moves had already occurred in response to Republicans retaking the White House and the Senate and looking likely to eke out a narrow majority in the House of Representatives. Stocks soared and bond yields jumped. It is clear that the second Trump administration will come into office with a very strong mandate given wide margins of victory in both the electoral college and the popular vote. This would suggest a determined pursuit of policy changes in a whole range of areas, with investors particularly focused on trade, immigration, and fiscal policy. Campaign proposals on all these fronts are, without a doubt, directionally inflationary. Tariffs, deportations, and further tax cuts at a time when the budget deficit is already projected to consistently exceed 5% of GDP even on current law, all speak to the same outcome: higher inflation.
What is still very unclear is the magnitude of the inflationary impulse since we do notyet know exactly what policies will be a) proposed and b) approved. Timing matters:early, “all-in” action would be more inflationary, gradual with exceptions, less so.
Moreover, the very same policies can have very different effects depending on themacro context in which they are implemented. Take immigration, for example. Therewas a time in 2022 when the number of job openings exceeded the number ofunemployed by over 6.0 million; as of September, this measure of labor market supply tightness had shrunk to just 0.5 million. Other measures such as average weekly hours and the quits rate suggest the labor market is less tight today that itwas just prior to Covid, a view that Chair Powell expressed as well in the press conference. Deportations equate to a negative labor supply shock. But when they occur in a backdrop of declining labor demand, the ensuing inflationary impact mayprove to be fairly contained. Furthermore, immigration is not only a labor marketfactor. Yes, it raises labor supply, but it also increases demand for a range of items, specifically housing. A positive demand shock here in the context of inelastic supply is inflationary, a negative one could bring some relief. In conclusion: forecasting the ultimate outcome of all these potential policies is a highly uncertain exercise.
When asked about how policies changes may impact the economy and Fed policy,Chair Powell said the following: “we do not guess, we do not speculate, we do notassume” how policies may change. The Fed waits for actual proposals, then models possible scenarios, and decides afterwards if a change of course is needed. Ofcourse, markets are by their very nature going to speculate and seek to gauge the impact of as-yet-uncertain policy shifts. A lot of that has already happened (this is not to say there isn’t more to go). But the economy does not behave that way. And so,we intentionally hold back from making any big changes to the forecast at this time. We do agree that the scope for 2025 Fed easing has narrowed, but we do not believe it to have closed. We still see a 25 bp-cut in December, and at least three more similarly sized cuts in 2025.
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There's more to the Weekly Economic Perspectives in PDF. Take a look at our Week in Review table – a short and sweet summary of the major data releases and the key developments to look out for next week.
UK: Are BoE Projections Too Optimistic?
The Bank of England (BoE) lowered the policy rate by 25 bps to 4.75% as widelyexpected. The MPC votes were split 8–1, compared to 5–4 vote for August’s rate cut.The bank also confirmed a “gradual approach” to rate cuts, considering the impact of the latest Budget. None of this was surprising. The November cut was widely expected, and the market already concluded that large spending and front-loaded stimulus from the Budget would limit the scope of the rate cuts.
However, in our view, what was included in the bank’s November statement andmonetary report does not reflect the whole impact of the budget. Indeed, in the accompanying monetary report, the bank expected that the fiscal policy would lift GDP growth by “0.75% at their peak in a year’s time”, relative to August’s projections. CPI inflation was also boosted by “just under 0.5% at its peak” by theBudget. These estimates are based on the usual 15-day average of forward interest rates to 29 October, and completely ignore the yield spike following the Budget Announcement on 30 October. That said, the budget impact would have beenmore modest if the bank’s projections were based on the latest pricing.
The bank’s forecasts also included three scenarios with different degrees of inflationpersistence. The central forecast was based on the second scenario, which presumes the second-round effects of inflation dissipate more slowly than they emerged. The CPI inflation is forecasted to fall back to the 2% target over the medium-term in this scenario, conditioned on market interest rate expectations that bank rate will drop by around 100 bps to 3.75% by the end of next year.
The December rate cut which we previously expected not looks unlikely, but we would not rule it out completely. In addition, if services inflation continues to fall more meaningfully in coming months, rate cuts are still likely to accelerate early next yearand reach 3.5% - 3.75% by next summer.
RBA: An Outlier
The Reserve Bank of Australia (RBA) maintained rates at 4.35% and sounded afew notches more hawkish this week. There were more references (4) to ratescoming down “around mid-2025” than in August in the Statement of Monetary Policy (SoMP). In the press conference, Governor Bullock did not hint at rate cutssaying instead that she wants to “see more progress on underlying inflation coming lower”. She said a trimmed mean CPI at 0.8% is sufficient for seeing inflation comingback into the target band.
At this point we have to concede that prospects of cuts in the foreseeable future are zero. Only a sudden and rapid deterioration in the labor market or the economy may change this outlook, if not the RBA is on track for their first rate cut “around mid-2025”; even February 2025 now looks unlikely.
October’s labor market data will be released next week. We note that employment growth has been around 50k for the last four months and see the risk of a reversal, despite our optimistic estimate of 30k. Furthermore, Q3 GDP out on 4 December will also be closely watched for the RBA outlook.
Back to November, the RBA lowered their forecasts for GDP, inflation, wages closer to ours since September, although our inflation picks are more optimistic. GDP forecasts have been reduced to 1.5% (1.7% in August) in December 2024 and 2.3% each for June and December 2025 (2.6% and 2.5%). So the Bank is clearly setting a high-bar for rates, which is quite odd for a central bank to do at the current global cycle. Trimmed mean CPI projections are also lowered to 3.4% (from 3.5%) in December 2024, 3.0% (3.1%) in June 2025 and 2.8% (2.9%) in December 2025. Our outlook is more optimistic, as highlighted by our SSGA Australia Inflation Indicator, updated after the Q3 CPI data below.