News of the week summary - 06/09/2024

ECB cuts rates

The European Central Bank (ECB) has reduced interest rates for the first time in nearly five years, lowering its main rate by a quarter-point to 3.75%. This decision, marking a significant step in addressing inflation, comes after a prolonged period of rising prices.

ECB President Christine Lagarde emphasized that while this move could be the start of a series of rate reductions, any further cuts would hinge on continued improvements in inflation data. Several ECB Governing Council members noted that another rate cut in July is unlikely due to recent increases in inflation and wage growth. 

The ECB aims for a 2% inflation rate, which is considered conducive to sustainable economic growth. The rate cut responds to a significant decrease in Eurozone inflation, which has fallen over 2.5 percentage points since the last rate hike in September 2023. Despite this progress, the ECB projects that inflation will remain above its 2% target until the final quarter of 2025, forecasting average rates of 2.5% in 2024, 2.2% in 2025, and 1.9% in 2026.

The decision aligns with similar moves by other central banks, including the Bank of Canada, which also cut its policy rate this week (to 4.75%). However, the US Federal Reserve and the Bank of England are expected to maintain their higher rates in the near term, reflecting different inflation dynamics in their economies.

US Job market surpasses expectations

In May, the US job market added 272,000 new jobs, significantly more than the predicted 180,000. This strong performance has adjusted market expectations regarding the Federal Reserve's timeline for interest rate cuts.

President Joe Biden, facing scrutiny over his economic policies from former President Donald Trump as the presidential election approaches, celebrated the impressive job growth. He emphasized the sustained low unemployment rate, which has remained at or below 4% for 30 consecutive months—marking the longest stretch in 50 years. 

The release of these job figures has impacted market sentiment. The likelihood of an interest rate cut at the Federal Reserve’s mid-September meeting fell from around 80% to 60%, according to market pricing. Previously, markets had fully priced in a rate cut by November, but now this expectation has been delayed to December.

The job market report also influenced Treasury bond yields. Treasury yields and interest rates (realised or expected) have an inverse relationship; when interest rates rise, the yields on existing Treasury bonds fall because their lower interest payments become less attractive compared to new bonds issued at higher rates. Conversely, when interest rates decrease, the yields on existing Treasury bonds rise as their relatively higher interest payments become more attractive to investors. The yield on the two-year Treasury bond, which is sensitive to interest rate expectations, rose by 0.14 percentage points to 4.86%.

Strong growth of Chinese exports

China experienced a notable increase in exports in May, with a year-on-year rise of 7.6% in dollar terms, exceeding economists' expectations of a 6% increase. This growth represents the highest export figure since April of the previous year. On the import side, growth was more modest at 1.8%.

This performance indicates stronger international demand at a time when domestic consumption within China remains low. The export boost is particularly beneficial for Chinese policymakers, who are targeting an annual GDP growth rate of about 5% for 2024.

President Xi Jinping's administration has concentrated on bolstering manufacturing to counteract the prolonged slowdown in the property sector. However, this focus on industry has faced criticism from the US and the EU. The EU is set to release the results of an investigation into subsidies for Chinese electric vehicles (EVs) next week. Meanwhile, the US has imposed 100% tariffs on imported Chinese EVs, effective from August, though these tariffs are expected to affect only a small volume of imports. Despite these tensions, Chinese auto exports have surged by 20% so far this year.

Oil prices decline 

Over the past week, Brent crude has fallen by almost 8%, driven by rising oil inventories and weak economic indicators, which have sparked concerns about sustained global demand. 

The decline follows an announcement from OPEC+ over the weekend, indicating plans to reintroduce a small portion of their previously curtailed output this year. Eight member countries agreed to reverse some of their voluntary production cuts. This was compounded by Monday's report showing weaker-than-expected US manufacturing data for May. 

OPEC+ had maintained significant production cuts, withholding about 3 million barrels per day from the market since late 2022. The recent decision to increase output later this year includes a provision to halt or reverse the additional production if market conditions are unfavorable.

While OPEC+ is unlikely to flood the market, the decision to reclaim market share indicates a shift from prioritizing price over volume. This change makes the oil market more sensitive to economic data.

Presidential elections results in Mexico spark market instability

Claudia Sheinbaum, representing Mexico’s ruling party, has won the presidency with  more than 30 percentage points over her nearest rival, becoming the country’s first female leader. Her victory led to market jitters due to fears of radical constitutional changes. Investors responded by selling off the peso, which fell by 3.3% against the dollar, and the IPC stock index (tracking the major companies listed in Mexico) dropped by 4.8%.

Sheinbaum has pledged to maintain the previous president's (López Obrador) policies, including the doubling of the minimum wage and increased social programs. She emphasized a commitment to democracy, business freedom, and private investment. She also promised a corruption-free government with strict austerity measures. Mexico’s budget deficit is at its worst since the 1980s, exacerbated by expanded welfare programs and major infrastructure projects like a new oil refinery. Additionally, the country is grappling with severe criminal violence and infrastructure issues, including water and electricity shortages.