Central banks in the United States and Europe are finally considering that the time has come to begin a cycle of lower interest rates, after having considered the inflationary crisis that led to the Russian invasion of Ukraine and the end of the pandemic to be over.
Since 1981, when the Federal Reserve Bank of Kansas City convened monetary officials for a symposium in Jackson Hole, a mountain retreat in Wyoming, to discuss possible strategic changes for central banks, the conclave has grown in influence as a sleepless nightclub for its governors. And this summer was no exception.
Federal Reserve (Fed) Chairman Jerome Powell confirmed at the end of August that “the time has come” to begin rate cuts, which should begin with the body’s meeting scheduled for Tuesday and Wednesday next week. This expected cut will be in addition to the one that the European Central Bank (ECB) should approve at its meeting next week, in addition to the one it already approved in June after two years of increases.
The aim is to avert the spectre of a recession in the US and an industrial paralysis in the EU, with inflation giving way to growth, employment, productivity or fiscal consolidation.
As always, the Jackson Hole meeting left room for free interpretation by economists. But in general, they agree in anticipating the arrival of a rate-cutting cycle that will last two years, geopolitical tensions permitting, to regain the momentum lost since 2023, when monetary authorities worked hard to contain interest rates. the biggest inflationary escalation in 40 years.
This cycle will be nothing like the bazooka-style firing used to deliver urgent monetary stimulus after the credit meltdown of 2008 or the great pandemic of 2020, which left rates near zero. But it will be precision fire. And steady.
Bankers’ deliberations this summer left messages that aren’t entirely cryptic, warns Adam Posen, president of the Peterson Institute for International Economics. Powell’s admission, he says, confirms the Fed’s shift in direction but obscures the priority it will give to GDP, which is subject to frequent and increasingly intense recession warnings, and to employment, which has shown early signs of weakness.
As the crucial White House election approaches, inflation has ceased to be the income-devouring ogre that Donald Trump so tirelessly invokes for the Fed. Its strategy has been aligned with the Keynesian stimulus measures of Bidenomics—notably subsidies for industry and renewable energy—that have repeatedly kept the world’s leading economic power from falling into the red.
Posen’s diagnosis is clear. Powell has highlighted the fragility of the labor market. His entire thesis revolves around the decline in job creation, but “without specifying any other economic factor that has a substantial impact on the American situation,” he explains to Bloomberg.
According to this analyst, this is a serious mistake, because even if the recruitment of jobs is the first concern, to calm inflation – which in the United States still remained at 2.9% in July – and stimulate business activity and consumption, there are other components such as productivity, budget adjustments, supply shocks or trade policy that the Fed “should take into account”.
This is the dark side of Powell’s speech, because, Posen points out, it affects prosperity and job creation. In August, the U.S. economy generated 142,000 new nonfarm payrolls, well above the 89,000 in July. The labor market recovered from the previous month’s poor data just before the Fed’s meeting next week, even though fewer jobs were created than expected.
In August, the unemployment rate fell by a tenth, to 4.2%, after increasing by two tenths in July, and is not far from the 3.4% recorded after the pandemic. It is still evolving within the framework of full employment, at levels below 5% of the active population. And the GDP is not issuing negative records either, the pace of which corrected by 2 tenths upwards, to 3%, between April and June. But several traces suggest a contraction.
For Posen, what Powell wanted to avoid is that, without facing a crisis, the United States would have accumulated a list of imbalances, among them the creeping deficit, the exorbitant debt, the tension in its real estate market and, of course, the productive and competitive gap that has emerged in recent decades. But for now, they can be served with a short rifle, without excluding the possibility of more aggressive monetary weapons in the future.
First shield: progressive reductions
Nothing that could not in principle be solved by rate cuts if they are quick and forceful. The market consensus anticipates a quarter-point cut this month, although the FedWatch predictor tool from the CME estimates that it should be 0.5%.
Clément Inbona, manager of La Financière de l’Echiquier (LFDE), maintains that Powell “has changed priorities”: from price stability to the revival of GDP and employment, the other objectives of the statutory trident that the Fed must monitor. The fall in inflation allows Powell to concentrate on strengthening the labor market.
A real relief because “telluric movements that have remained buried until now are emerging,” such as the increase in youth unemployment and the resurgence of a threshold reached over the last 80 years and that Posen also highlights, the so-called Sahm Rule. This theory, named after Claudia Sahm, a former Fed economist, guarantees that when the average unemployment rate over a quarter is at least 0.5% higher than its lowest level recorded last year, a recession is inevitable. And both emphasize that this limit has just been exceeded.
In Europe, the scenario is not too different. Analysts consider that the ECB will leave rates close to 3% in the medium term, a step considered neutral and that its hawks have imposed as an insurmountable barrier until they verify that inflation falls below 2%, against 2.2% in the middle of August at the minimum for more than three years. The market is a little more optimistic, experiencing two or three downward movements this year, compared to 4.25% in June.
Investors are forecasting six cuts through 2026, when they would remain at 2.5%. Several funds are even targeting 2% if the cut is half a point.
The German Isabel Schnabel, one of the most precise advisers in anticipating the ECB’s maneuvers, acknowledged that “it might be necessary” to place the price of money below the neutrality threshold, which economists set at 2.5%. Of course, without forgetting the counterweight: “It would be opportune to first witness a period of disinflation”, despite the fact that in August the CPI of the euro fell by another 4 tenths.
The dynamism-price clamp mentioned by Schnabel illustrates the classic monetary debate that, also in Europe, is beginning to lean towards economic revitalization and employment. This is justified by indices such as the S&P Global PMI, which went from the level of 50.2 in July (barely 2 tenths above the contraction) to 51 points, but with a drop in orders – especially industrial – and employment.
These records were recorded despite the slight drop in the price of silver initiated by the ECB in June, which did not prevent the Black Monday of the stock market in August due to global monetary restrictions and the lack of discipline on the deficit and debt of high-income countries. powers. With Spain, Ireland and, to a lesser extent, Italy, pulling the car, France seized the weight of the consumption of the Olympic Games, although lagging behind the 53.3 points of the Spanish calculation. Germany, on the other hand, experienced its second monthly decline.
To the aid of Germany
The German industrial paralysis is at the origin of the possibility raised by Volkswagen to close factories in the largest economy of the eurozone. Something unprecedented in its 87-year history that reflects the crisis that the European automobile sector is going through. In particular, Germany, after having ignored for decades its “overcapacity” and having plunged into a clear “brake on competition”, the problems that Mario Draghi cites in his diagnosis of the shortcomings of the euro economy and his recipe for increasing productivity and competitiveness, compared to the productive and commercial power demonstrated by the flourishing Chinese electric car industry or even by the American Tesla.
Despite this, German manufacturing orders rose 2.9% in July for the second month, after a surprising 4.6% in June, following the ECB’s rate cut and after five negative months.
Frankfurt’s monetary turn aims, once again, to pull the euro locomotive out of the quagmire. The new contraction of a tenth of GDP between April and June put an end to the slight rebound, of 0.2%, of the first quarter. Its recovery would allow to restore the potential of the currency zone, well above the 0.3% growth recorded during the first two quarters of the year.
The traditional locomotive of the euro “oscillates between hope and despair”, sums up Carsten Brzeski, analyst at ING, while “it slows down the activity of its partners”. The German Council of Economic Experts predicts growth of 0.2% for the whole year, but under quarantine: to the detriment of a new flowering of industrial orders.
An unknown that could lend credibility to the analysis of ECB economists who estimate that nominal rates would have a floor at 1.25% and which comes at a crucial moment for Olaf Scholz’s coalition, under pressure to modify its economic policy with adjustments, budgetary controls, immigration controls and even cuts in the welfare state, after the recent emergence of the neo-Nazis of the AfD in the elections in the eastern Länder of Thuringia and Saxony.
For its part, the Bank of England has just lowered its rates for the first time in five years, to 5%, to consolidate a notable increase in its GDP, of 7 tenths between January and March and 6 between April and June. The world’s sixth largest economy aims to emerge from the succession of recessive phases that have characterized the decade and a half of conservative governments. And this has been associated with the depreciation of silver.
“Something changes when economies that are showing strength, like the US, don’t move away from recession fears and the market calls for greater credit docility,” says David Rosenberg. The investor has compiled up to 20 indicators that point to an inexorable end to the US economic cycle. These signals could lead to “further overreactions in stock markets,” says Lara Castleton of Janus Henderson Investors.
