Market Brief: US Rate Cut Expectations Tumble Ahead of Jackson Hole

The trade-weighted dollar is holding near a two-week high after yesterday’s hotter-than-anticipated activity data triggered a dramatic reappraisal of the Federal Reserve’s expected easing trajectory, lowering expectations for a clear rate-cutting message from chair Jerome Powell at this morning’s economic symposium in Jackson Hole. Benchmark ten-year Treasury yields are holding steady around the 4.33-percent mark, equity futures are setting a course toward an advance at the open, and most major currencies are holding just below technically-important levels as traders await further clarity before pushing them lower.

US private sector activity expanded at the fastest rate recorded so far this year in August, led by a snappish recovery in the manufacturing sector, which saw its strongest growth in orders in 18 months. S&P Global’s flash composite purchasing manager index, which measures the services and manufacturing sectors, climbed to 55.4 earlier this month, above the 50 threshold that separates expansion from contraction, and well above market expectations. According to S&P, businesses “took on additional staff in response to tising backlogs of work” and “uncompleted orders rose for a fifth consecutive month, rising in August at a pace unsurpassed since May 2022”, suggesting that a surge in inventory rebuilding could be underway. Price growth accelerated however, with average prices charged for goods and services climbing at the most aggressive rate since August 2022 as businesses passed tariff cost increases on to consumers.

This combination of accelerating growth and building price pressures simply isn’t consistent with aggressive rate cuts from the Fed. Money markets are now putting sub-70 percent odds on a move in September, and less than two moves are priced before year end, down sharply from levels reached just a week ago.

Investors are uncertain as to whether Jerome Powell will table a September rate cut at this morning’s appearance. After July’s disappointing non-farm payrolls report, the chair is likely to acknowledge a slowing in the pace of job creation, but could also note that the supply of workers is falling in line with demand, easing pressure on the unemployment rate—and on indicators like continuing jobless claims, which have been trending upward at a glacial pace. So-called “no-hire/no-fire” dynamics remain intact. But inflation is still above the central bank’s target, and is widely expected to accelerate in the months ahead. And growth is proving far more resilient than had been previously expected. It is difficult to imagine the chair providing clear-cut guidance against such a complex backdrop—but markets have been surprised before.

Here in Canada, consumers are looking exhausted, and the loonie looks vulnerable to further weakness. Advance retail sales data published by Statistics Canada this morning showed spending levels falling -0.8 percent in July, reversing direction after June’s 1.5-percent gain, with core—auto and gas excluded— receipts rising just 0.9 percent in the second quarter after a 1.8-percent rise in the first three months of the year. The loonie is trading north of the 1.39 threshold as investors weigh the likelihood that further demand destruction could push the Bank of Canada into cutting rates at least once more this year. From a technical standpoint, May’s levels are now in range, with the currency exposed to a move closer to the 1.40 threshold before the end of the summer—but we would also caution that a range of other indicators point to oversold conditions, suggesting that the currency could stage an unexpected recovery, leaving unhedged participants in the lurch.

Across the pond, the German economy shrank more than expected in the second quarter, but yesterday’s activity data pointed to a modest recovery ahead, and today’s measure of euro-area pay growth exhibited signs of acceleration. Revised data showed gross domestic product in the euro area’s biggest economy contracting -0.3 percent in the three months to June as investment and industrial production levels deteriorated, suggesting that export-focused sectors suffered a reversal of the first quarter’s front-loading effects. The outlook looks brighter for the third quarter however: yesterday’s purchasing manager update showed new orders and sentiment levels turning up in early August. Separately, negotiated wages across the bloc rose 4 percent in the second quarter from a year prior, up from 2.5 percent in the first three months of the year, potentially pointing to second-round upside risks for inflation.

The European Central Bank should remain sidelined for now. Benchmark lending rates in the bloc are already close to neutral, “bullwhip effects” are playing out across export sectors, fiscal stimulus is putting a very modest tailwind behind overall growth, and the Bank’s own forecasting tools suggest that wage-led inflation will subside in the months ahead. If the euro attempts another rally this year, we suspect that the impetus will come from a change on the US side of the economic equation.

Next week will deliver only two first-tier data releases here in North America, with both inconveniently timed to land on Friday morning, when traders, policymakers, and humble foreign exchange strategists might otherwise have been beach-bound. In the US, the core personal consumption expenditures index—the Fed’s preferred inflation indicator—is seen climbing 2.9 percent in the year to July, up from 2.8 percent in the prior month on an acceleration in services prices, with portfolio management fees expected to make a significant contribution to the headline gain. Personal income and spending levels are both likely to have risen 0.4 percent in the month, pointing to further resilience on the household side of the economy. Here in Canada, the economy may have entered a modest contraction in the second quarter after tariff front-running efforts artificially boosted net export volumes in the first three months of the year. Updated gross domestic product numbers from Statistics Canada are expected to show growth falling roughly -0.5 percent in seasonally-adjusted annualised terms.

Please note: Amid the typical late-August decline in trading volumes and market volatility, we will pause distribution of the daily market brief until Wednesday, September 3, but will hit your inbox with coverage of any significant market events in the interim.

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