Markets Pivot Toward a 50-Basis-Point Cut from the Fed

As economic data from the U.S. is released and officials share insights regarding their next moves, market expectations about the Federal Reserve's policy path are shaping up. Expectations for another 50-basis-point cut by the Fed, which were quite unclear at the beginning of the week, are now beginning to solidify.

The preliminary September PMI readings, released on Monday, showed that while the contraction in the U.S. manufacturing sector has deepened, the economy continues to remain in expansionary territory, driven by the services sector.

Additionally, the Consumer Confidence Index report published yesterday revealed a drop from a revised 105.5 in August to 98.7 in September. The Present Situation Index, which reflects consumers' assessment of current business and labor conditions, also fell by 10.3 points to 124.3.

The report indicates that consumer confidence in the U.S. has recorded its biggest drop since August 2021, falling below the narrow range that has dominated for the past two years. Despite a healthy labor market with low layoffs and high wages, slower payroll growth and fewer job openings are causing consumers' perceptions of the labor market to turn negative.

Following these developments, market expectations have started shifting towards another half-point rate cut from the Fed. According to futures market data, pricing has reversed compared to last week, with a 60% probability now assigned to a 50-basis-point cut at the November meeting.

Meanwhile, markets are looking for clues from Fed officials' statements regarding the extent of the next move, though the signals remain mixed. Chicago Fed President Austan Goolsbee has suggested that rates need to be cut significantly to support the economy, and Atlanta Fed President Raphael Bostic indicated he might support more aggressive easing depending on the data.

Conversely, Fed Governor Michelle Bowman emphasized inflation risks, suggesting that rates should be reduced at a "measured" pace. Meanwhile, Minneapolis Fed President Neel Kashkari and Governor Christopher Waller signaled their support for a quarter-point rate reduction for the remainder of the year.

As market expectations continue to evolve based on developments, the ongoing decline in U.S. yields is influencing dollar forecasts. Goldman Sachs has revised down its forecasts for the dollar against several currencies. The bank now expects the euro to rise to 1.15 against the U.S. dollar over the next 12 months, the pound to climb to 1.40, and the yen to fall to 140 per dollar.

In terms of short-term pricing, expectations around the pace of the Fed's rate cuts will remain crucial. In this context, Friday's release of the PCE price index could further steer expectations.

China Unveils Largest Stimulus to Revive Stalling Economy

The People's Bank of China has announced its largest support package to date to revive the stalling economy. At a press conference on Tuesday, Governor Pan Gongsheng announced a reduction in the reserve requirement ratio, the seven-day policy rate, and existing mortgage rates to both boost lending and ease the burden of existing loans.

The seven-day reverse repo rate was reduced from 1.7% to 1.5%, while the medium-term lending facility (MLF) rate was lowered to 2%. This cut marks the largest reduction since 2016.

Furthermore, the reserve requirement ratio (RRR) was cut by 0.5 points, releasing 1 trillion yuan in liquidity. The RRR is expected to decrease by an additional 0.25 to 0.5 points throughout the remainder of the year.

Significant support was also announced for the real estate sector, which has been the largest source of pressure on the economy. An average of 0.5 points reduced the unpaid mortgage rates for individual borrowers. The minimum down payment for second-home purchases will also be lowered from 25% to 15%.

The markets welcomed the announced package; the yuan fell below 7 per dollar for the first time in 16 months. Following the 500 billion yuan support for the stock market included in the package, Chinese stocks rose.

This package could potentially make China's 5% growth target achievable, but doubts remain about whether it will be sufficient to overcome long-term deflationary pressures and the entrenched real estate crisis. Some economists warn that the announced stimulus measures may not be strong enough to boost consumer demand and that their effects could be temporary.