The latest Employment Situation report prior to the next FOMC meeting (28-29 January) points to the surprising strength of the US labour market, illustrated by job creation at its highest level since March 2024. Publication concluded a week marked by a significant rise in bond yields against a backdrop of expectations of rates "higher for longer", leading to sharp movements on the financial markets.
2024 was marked by further progress in disinflation, in both the United States and the Eurozone, sufficient to pave the way for rate cuts. However, 2025 may be quite different from 2024, with expected divergent inflation trajectories between the United States and the euro area and, therefore, a decoupling of monetary policies (extended status quo for the Fed, continued gradual rate cuts for the ECB).
The Fed ended the year with a reduction in its target rate (-25 bp), which now stands at +4.25% to +4.5%. Meanwhile, median expectations by committee members of the number of cuts fell from four to two for 2025. The response from the financial markets was abrupt.
A turbulent 2025 is expected to follow a 2024 marked by dynamic growth and the start of a monetary easing cycle. While growth is expected to slow towards its long-term level, the political plans associated with the change of president and Senate majority suggest an increase in inflationary risk. As a result, the Federal Reserve is expected to put a premature end to rate cuts.
The U.S. Foreign Trade is structurally in deficit.In 2023, the deficit in the balance of goods exceeded one trillion dollars, which amounted to 3.8 percent of GDP.While this may be seen as a reflection of the strength of the American consumer, Donald Trump analyzes it as the result of ‘violent treatment’ and ‘abusive practices’ from his trading partners.
Economic growth in the United States remained strong in Q3, with GDP growth of +0.7% q/q (stable compared to Q2). The acceleration in household consumption (+0.9% q/q, +0.2 pp) confirmed its role as a growth driver, while non-residential investment (+0.8% q/q) and government spending (+1.2% q/q) also made a positive contribution. Conversely, residential investment and net exports were a drag. In Q4, we expect growth to decline slightly to +0.5% q/q, which would bring the average annual growth rate to +2.7% (-0.2 pp) for 2024 as a whole.
For the time being, Donald Trump has not specified his intentions on banking regulation. However, there is a risk that he will push for an incomplete translation of the finalisation of Basel 3 into US law. This would undermine efforts to harmonise international prudential frameworks and introduce significant distortions of competition between US and European banks.
The second-last FOMC Meeting of 2024 has resulted in a 25bps cut in the Fed Funds Target Range, to +4.5% - +4.75%. The steps ahead promise to prove trickier for the Fed, as the landing is still pending, and in view of Trump’s win. Indeed, the President-elect’s hostility towards Powell is common knowledge, while many of his policy plans are associated with an increased inflation-risk.
The presidential election on 5 November is associated with underlying but potentially decisive economic issues.Political aspects: The election pits Vice President Kamala Harris (Democrat) against former President Donald Trump (Republican). The winner will take office on 20 January 2025. The election looks set to be particularly closely contested, despite the momentum in Donald Trump's favour at the end of the campaign. At the same time, voters will be deciding on the composition of the next Congress, which will significantly affect the new administration's room for manoeuvre.Economic context: The vote comes against a backdrop of an apparently stronger economy. This is illustrated by solid macroeconomic performances, despite recent shocks, which are seemingly auguring a soft landing
The outcome of the US presidential elections on 5 November will decide the extent of the protectionist turn taken across the Atlantic. However, global exports have so far resisted the rise in tariff barriers. By the end of the decade, the IMF forecasts growth in exports of goods similar to or even slightly higher than that of world GDP. Tighter protectionist measures will affect global growth, but the effects on international trade will be more nuanced.
U.S. economic growth, a priori, remained robust in the third quarter. The Atlanta Fed’s GDPnow estimates GDP growth at +0.8% q/q (+0.1pp compared to Q2 2024). Household consumption remains the principal driver, as illustrated by the acceleration of the retail sales control group in September (+0.7% m/m, +0.4pp). Activity in services improved in the same month in view of the jump in the ISM non-manufacturing index to 54.9 (+3.4pp). On the other hand, the ISM manufacturing index remained in contraction territory, stable at +47.2 despite the improvement in the “output” component (+5.0pp).
The sun was shining last week in Washington, DC during the Annual Meetings of the International Monetary Fund (IMF), but the imminent US elections cast a shadow over the meetings of the Finance Ministers, Central Bank Governors, and private sector economists and finance professionals from all around the world who gathered in town. The better-than-expected state of the global economy was obscured, and all other conversations relegated to second or third billing, including the IMF’s usual warnings about various dangers (excessive debt, insufficient growth, protectionism), the outlook for Europe (improving), for China (as well), for other EM (generally good) and digital finance (further gaining status).
On 30 September, the Federal Housing Finance Agency (FHFA) announced its intention to raise counterparty exposure limits on the deposit accounts of Federal Home Loan Banks (FHLB) to the same level as those limits set for their federal funds loans, an approach already discussed in its December 2023 report. This harmonisation could lead FHLBs to favour deposits with banks, as these are better remunerated. Supply on the federal funds market, on which FHLBs occupy a prominent position as lenders, would be reduced, driving up the effective rate of federal funds.
On 18 September, the Federal Reserve (Fed) decided to lower its target range to +4.75% - +5.0% (-50 bps), initiating an easing of rates that looks set to continue during upcoming FOMC meetings. The direction of the movement is driven by the simultaneous slowdowns in the labour market and inflation. The scale of this movement aims to maintain a dynamic economy and falls within a broad and unprecedented interpretation of its dual mandate. Our baseline scenario suggests that disinflation will continue during the projection period with no recession in the meantime. At the same time, the United States is heading towards an even more significant presidential election than usual.
The September FOMC meeting kick-started the Fed’s easing cycle with a significant 50bps cut in the Federal Funds Target Rate, leaving it at +4.75% - +5.0%. Unusually, this large step was taken even as the US economy remains strong, and explicitly with a view to keeping it so. Effectively, macroeconomic conditions having induced a shift in the Fed’s priorities towards the ‘maximum employment’ component of its dual mandate, while still not declaring mission accomplished on the inflation side
We expect September 17-18 FOMC Meeting to result in a 25bps decrease in the Federal Funds Target Rate to 5.0% - 5.25% - barring a huge surprise. This move will launch the beginning of an easing cycle for monetary policy. The combination of improved data and outlook for inflation and the ‘unmistakable’ softening of the labour market leads to a shift in the Fed’s priorities, paving the way for rate cuts. A few thoughts beyond the direction change:
While the date of the Fed's first rate cut is now foreseeable (it will be at the FOMC on 17-18 September), everything else remains uncertain: the size of the cut, as well as the overall extent of the easing cycle and the timing of the cuts. Developments on the US labour market are key in this calibration. In terms of inflation, significant progress has been made regarding the return to price stability on both sides of the Atlantic, but the battle is far from won. This calls for caution in the monetary easing that is beginning
Historical relationships between economic data play a key role in shaping expectations. In the US, the Sahm rule is such an important stylised fact: when the recent increase in the unemployment rate reaches a certain threshold, a recession tends to follow shortly or has even already begun. The jobs report published early August showed that this critical value had been reached, triggering a drop in investor sentiment. At the Jackson Hole conference, Jerome Powell explained that the Fed’s focus is shifting to the labour market and brought an unambiguous message that the rate cutting cycle is to start in September
Expectations in terms of growth for Q2 remain favourable: we expect it to be +0.6% q/q compared to +0.5% q/q for the Atlanta Fed's GDPNow. However, several elements suggest a more difficult Q3. The ISM surveys in June returned a negative signal: mixed for the manufacturing component, which deteriorated marginally, to 48.5 (-0.2 points), against a backdrop of falling production (48.5, -1.7 points), more marked for the non-manufacturing index, which fell to 48.8 (-5.0 points), against a backdrop of a correction in activity (49.6, -11.6 points), and a deterioration in new orders (47.3, -6.8 points). The NFIB (Small Business Optimism Index) again rose only slightly in June (91.5, +1
US growth has clearly moderated in the first half of the year and the latest data for the Federal Reserve’s preferred inflation metric (core personal consumption expenditures inflation) have been welcomed by the Fed and financial markets. The latter are now pricing in a high likelihood of a first rate cut in September. Faced with a still low but rising unemployment rate, the focus of the Federal Reserve is shifting. From exclusively looking at inflation, economic activity and employment also start to matter now, even more so considering the latest progress in terms of disinflation.
Having a good understanding of a central bank’s reaction function is important. It influences inflation and interest rate expectations, the level of bond yields, investor risk appetite and economic confidence in general. In the US, different types of information help to improve our understanding of the Federal Reserve’s reaction function: monetary policy rules -which play a prominent role in the material prepared by the Fed staff for the FOMC meetings-, the relationship between inflation, growth, unemployment and the federal funds rate in the Summary of Economic Projections of FOMC members as well as speeches and press conferences
Since a 1977 act, the dual mandate of the Federal Reserve (Fed) has de jure entrusted it with the objectives of maximum employment and price stability (the latter being expected to favour the former in the long term). However, these objectives can come into conflict and, as has been the case since March 2022, the Fed may have to give clear priority to reducing inflation at the risk of damaging employment and output. This refers to the concept of sacrifice ratio or trade-off, i.e. the expected cumulative deterioration of the latter to help bring inflation back to its target (2%).
US inflation seems to have resumed its downward trajectory in Q2 2024, after a Q1 of price acceleration that led the Federal Reserve (Fed) to revise, in June, its expectations for rate cuts for the year (from three to one, in line with our own forecasts). At the same time, economic activity remains strong, although it has lost some of its momentum.
The massive monetary tightening policy undertaken by the Federal Reserve, starting in March 2022, in order to combat soaring inflation, has driven up mortgage interest rates. This sharp uptick in rates has in turn led to a significant deterioration in demand metrics of the US residential real estate market (notably mortgage applications and existing home sales).Nevertheless, the buoyancy of the US economy at the aggregate level and the healthy financial situation of households have prevented the housing crisis from turning into a systemic crisis. The surge in mortgage rates has also affected the existing home supply, prompting a lock-in effect which has led to an unprecedented divergence between new and existing home sales, which was although insufficient to support the whole market.
The still-elevated level of inflation in annual change and its increasing momentum have continued to adversely affect morale in US households. In April, consumer confidence, as measured by the Conference Board, fell for the third month in a row (97.0, -6.1 pp), ultimately cancelling out the progress seen at the end of 2023. Similarly, the University of Michigan survey reported a drop in its Index of Consumer Sentiment in May, with a score of 69.1 (-10.5), the lowest since November.
