Entering the summer doldrums
Bond yields at the end of June were little different to the start of the month, with changes of only 1-8 basis points in the benchmark 10 year yields across the UK, USA and Germany. True, there was some volatility during the month, with yields generally declining about 25 basis points before rising back to end flat on the month. In broad terms, the markets and indeed the major central banks remain in ‘watch and wait mode’. When will a major new economic trend appear, or perhaps political developments will spark a substantial change in view?
The downtrend in yields during June was caused by a few more signs that the US economy is slowing moderately into the summer. Retail sales data can move around month to month, but the latest data for March, April and May suggests that the 3-month annualised growth rate is only running about 1.6%. The latest IMF forecasts had suggested that the US will grow 2-3% this year. Investors were also pleased with the latest core inflation data. The Fed’s favourite core PCE inflation gauge for the US economy decelerated to 2.6% in the year to May, the lowest since March 2021.
However, such a figure is still above the Fed’s 2% target, whilst labour market data during the month still do not suggest any major change in wage pressures. Hence, a succession of Fed Governors insisted that they are not going to ease monetary policy quickly. To quote Philadelphia Fed President Patrick Harker “If all of it happens to be as forecasted, I think one rate cut would be appropriate by year’s end”, in what he sees as a “long glide” back to target for inflation. Similarly Michelle Bowman: “Should the incoming data indicate that inflation is moving sustainably toward our 2% goal, it will eventually become appropriate to gradually lower the federal funds rate to prevent monetary policy from becoming overly restrictive. We are still not at the point where it is appropriate to lower the policy rate”. September is still seen as the first month when rates might be cut. As Adriana Kugler said, “If the economy evolves as I am expecting, it will likely become appropriate to begin easing policy sometime later this year”.
Over this side of the Atlantic, the ECB has cut rates once so the debate has moved on to when a second move might be seen. After all, the economy is only growing slowly – IMF forecasts are about 0.5-1.0% GDP growth in 2024 – whilst inflation is slowly decelerating and inflation expectations easing. The effects of tight monetary policy can be seen through Euro area credit growth to businesses remaining subdued.
On this basis the financial markets are pricing in two further rate cuts in 2024. Certainly ECB Governing Council member Olli Rehn is happy with such a view. “If you look at market data, it implies that there would be two more rate cuts so that we would end up at 3.25% by the end of this year and, with the terminal rate somewhere around 2.25-2.5%. In my view, they are reasonable expectations. In case we see the disinflationary process continuing and moving toward our symmetric 2% target of the medium term, then it is reasonable to assume that we stay with this direction and continue rate cuts”.
The economic background underpinning the Monetary Policy Committee’s decision making is rather closer to that of Europe than the USA. According to former MPC member Michael Saunders, the BoE is likely to cut interest rates soon, “probably in August”, as long as inflation and wage data align with its May forecasts. “They have clearly signalled they are willing to cut soon if data are ok”. The Bank’s economists would have been pleased with the latest inflation figures. Headline CPI in May slowed to 2% year on year, the lowest since July 2021. Durable goods prices sank further into deflation, offsetting continued strength in the services sector. So wages and labour market developments will be key. Unfortunately, the latest data was mixed. So far this year the unemployment rate has edged up steadily, from 3.8% to 4.4%. However, there has been little change in the underlying average earnings excluding bonus figures, still running about 6% from a year ago. The Bank would prefer some evidence that trends in the labour market align with its inflation mandate before it can relax monetary policy to any great extent. As soon as the General Election is out of the way, and MPC members can speak more freely, we will see from their commentary how they are assessing the situation into the summer.
Bond yields at the time of writing
10 year % Monthly move
USA 4.41 -0.08%
UK 4.23 +0.01%
Germany 2.58 -0.01%
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making