US rate cut seems distant as inflation report looms

Key points

• Nonfarm Payrolls impact on rate cuts: The upside surprise in the US Nonfarm Payrolls has shifted market expectations, now predicting only one rate cut in December, a significant change from the seven cuts anticipated at the beginning of the year and the Fed's forecast of three cuts. This shift suggests the Fed is becoming more cautious and delaying the rate cut cycle due to inaccuracies in its own models.
  
  
• Nowcasting in economic forecasting: The concept of nowcasting, which involves short-term forecasting of key economic indicators, is highlighted as a valuable tool amidst noisy macroeconomic data. Using real-time data sources like the Redbook same-store sales index and the Dallas Fed Weekly Economic Index can provide more accurate predictions, reflecting the recent acceleration in the US economy.
  
  
• Current economic and market conditions: Positive performance in risk-on asset classes such as developed and emerging market equities contrasts with the negative performance in commodities, private equity, and small caps. The global economic backdrop remains positive, with no stress signals from financial markets, supporting a favorable environment for equities and other risk-on assets.

The value of nowcasting as Nonfarm Payrolls shock investors

Ahead of Friday’s upside surprise on US Nonfarm Payrolls market pricing was evenly divided between the Fed cutting rates either at the September or November meeting. As we will soon publish in our Q3 quarterly outlook our view is that the economy and markets will hum along in Q3 and that macroeconomic indicators are generally supporting this view. Our views have generally been on the positive side and we have multiple times spoken into resilient US data and that inflation would surprise to the upside. After the Nonfarm Payrolls figures on Friday the market is now only pricing in one rate cut and earliest at the December meeting. Quite far from the seven rate cuts priced in at the beginning of the year and the Fed’s own forecast this year for three rate cuts. The fact that the Fed’s own models have been wrong again is likely making the Fed more cautious and thus delaying the rate cut cycle.

There is so much noise in macro indicators right now that it can be difficult to choose what to put a weight on. In our team, we are putting weight on the concept of nowcasting. The idea is to keep the forecasting horizon short (hence nowcast) and predicting key economic indicators such as real GDP that are published with a significant lag. If one had used the two weekly series called the Redbook same-store sales index and the Dallas Fed Weekly Economic Index then you would not have been surprised about the latest developments. The US economy has accelerated over the past couple of months. The advantage of using nowcasting is that you avoid making longer term predictions based on weak causality, but instead you go with the methodology applied in weather forecasting. If the current state is sunny weather then the likelihood of sunny weather tomorrow is very high. It is basically the same with the economy.