Outlook for the Week of September 2 – 6

Key points to watch out for:

• Traders see a 50 basis point Fed cut in September as feasible.
• Fed gives higher priority to employment data, NFP is awaited.
• Bank of Canada rate decision, third rate cut in a row is fully priced in.
• Australian investors watch out for GDP figures.

Expectations for a Likely Fed Rate Cut Remain High

For yet another week, investors are eagerly awaiting the NFP results to get a sense of the size and pace of the Fed’s next rate cuts. The weaker-than-expected July figures generated market turbulence, instilling fears about the possibility of a U.S. economic recession and prompting investors to estimate the Fed’s rate cuts by the end of the year at around 125 basis points.

However, data following the jobs report eased investors’ concerns, prompting them to reduce their bets. That said, Fed Chairman Jerome Powell’s dovish speech in Jackson Hole did not prompt them to change their bearish view considerably. Investors continue to expect interest rates to end the year around 100 basis points below current levels, with a 35% probability of a 50 basis point reduction at the next scheduled meeting on September 18.

Employment Data Begin to Take Center Stage

In Jackson Hole, Powell pointed out that “the time has come to tighten policy,” and regarding the timing of rate cuts, “it will depend on the data coming in.” He likewise placed special emphasis on the labor market, mentioning that they “would not look for or welcome further cooling of labor market conditions.” This makes the Non-Farm Payrolls on Friday, September 6, even more relevant, because signs of further cooling could convince traders that the Fed might begin its easing cycle with a bold 50 basis point cut. This could push Treasury yields lower and put further pressure on the U.S. currency.

Right now, the question hanging in the air is: How will Wall Street react? Could the tepid report put recession fears back on the table, or will equity investors rejoice at the estimate of even lower borrowing costs? The answer could be found in the ISM manufacturing and non-manufacturing PMI results for August, which will be released on Tuesday, September 3, and Thursday, September 5, respectively.

The Atlanta Fed’s GDPNow model forecasts respectable real GDP growth of 2.0% for the third quarter, and if the ISM prints point to improving activity, investors may maintain their confidence in the world’s largest economy, thereby increasing their risk exposure. Market participants can get some information on the state of the labor market ahead of Friday’s September 6 NFP.

On Tuesday, September 3, the July JOLTS job openings will be released, while on Thursday, September 5, the ADP employment report will be released. Thursday’s agenda also comes with data on nonfarm productivity and unit labor costs for the second quarter.

Bank of Canada Prepares for a Third Straight Rate Cut

In Canada, the Bank of Canada is expected to announce its interest rate decision on Tuesday, September 3, and Canada’s overnight index swaps (OIS) indicate that a third rate cut followed by a fourth rate hike is almost assured. There is even about a 15% chance of a more substantial 50 basis point cut. At its July meeting, the Bank of Canada announced its second cut in a row, leaving the door open for further action at subsequent meetings.

Since then, monthly GDP data showed that the economy slowed in May compared to April and approached stagnation in June. The employment report showed higher job losses in July compared to June, and increasingly relevant, inflation continued its downward trajectory.

The data justifies the estimate that the Bank will cut rates again at this meeting, which also suggests that policymakers will maintain a very accommodative stance. In such an event, the Canadian dollar could slide, but given that rate cuts have already been anticipated for each of the remaining meetings this year, it is unlikely that overall estimates for USD/CAD will change. Because of its risk-sensitive nature, the CAD has been enjoying recent inflows as risk appetite continues to be elevated in the face of aggressive Fed rate cut bets, and if U.S. data corroborates that idea, the prevailing downtrend in the USD/CAD may remain intact. Canadian employment data will be released on Friday, September 6, at the same time as the U.S. data.

Will the Australian GDP Figures Slow the Recovery of the Australian Dollar?

Australian traders will also be concerned this week as, apart from changes in overall market sentiment, they will have to digest Australia’s Q2 GDP data on Wednesday, September 4, as well as China’s Caixin services and manufacturing PMI data on both Monday, September 2, and Wednesday, September 4. During their last meeting, the Reserve Bank of Australia’s policymakers decided to keep interest rates unchanged at 4.10%, adding that they remain willing to tighten policy further, as inflation, although declining, remains high. However, the market does not expect further rate hikes. On the contrary, traders are almost entirely expecting a 25 basis point cut by the end of the year, and the poor data could confirm this view.

If so, the Australian dollar could lose some of its recent aggressive gains, although the fact that the Reserve Bank of Australia’s expectations are much less dovish compared to those of other major central banks, coupled with increased risk appetite, is likely to keep any associated GDP losses limited and short-lived.