July saw Paris host the greatest show on earth. 

Léon Marchand in the pool, Simone Biles on the gymnastics floor, Mijaín López in the wrestling ring.

After the busy start to the summer, most of us hoped/expected a quieter July. However, while the rest of the world was becoming an armchair expert on sports ranging from Taekwondo to diving, financial markets were fixated on their own event: the not-so-graceful dive of US Treasury yields.

Far from ‘faster, higher, stronger’, the mantra in financial markets was ‘faster, lower, weaker’.

Rate-cut pricing moved faster and global yields (and equity earnings) plunged lower, while US labour market data proved surprisingly weaker.

Just an action replay from December?

We’ve been here before. In the fourth quarter of 2023, global yields took a dive off the three-metre board. Markets got giddy about the prospect of imminent rate cuts. The combination of central bank commentary, some below-consensus data and a market desperate for lower yields into year-end, saw markets price in an aggressive cutting cycle.

US Federal Reserve (Fed) Chair Powell has repeatedly reminded us that the bank has a dual mandate: to secure stable prices and maximise employment. Back in December, inflation surprised on the downside. However, like Armand Duplantis in the pole vault, the jobs market just kept moving higher. This meant that when inflation surprised on the upside just a couple of months later, markets rapidly removed expectations of aggressive rate cuts, and yields Fosbury-flopped higher.

So yes, December 2023 was a false start – markets jumped the gun. Stronger employment during the first few months of 2024 and markedly sticky inflation (particularly in the US) showed that developed economies were far more resilient than first thought. Central banks were confined to the starting blocks for a bit longer.

Will we get a clean start this time?

We think so. The US labour market has fired the starting gun.

This current move is based on actual weakness.

The US jobs market is showing signs of strain. Unemployment has headed unexpectedly higher, American employees are not changing jobs as often, and the outlook from employers is markedly darker.

The rise in unemployment has been especially stark. Headline unemployment rose to 4.3% in July, up from 3.7% at the start of the year. For context, the Fed didn’t expect unemployment to shift from 4% throughout 2024. Even if the market jumped on that one data print, it’s clear the labour market is slowing on multiple metrics.

On the other side of the Fed’s mandate, inflation seems under control. Headline inflation is well on its way to target. Rental price pressure on core inflation has reduced and the cost of services is no longer strongly accelerating.

It’s time for the US to join the cutting race

We expect the Fed to cut rates from September. Trickier is forecasting the speed and the distance.

The speed? The initial reaction to the US unemployment data saw markets price an Olympic record pace of cuts. The speed of forecasted cuts has now slowed but is still maintaining a competitive pace. This is a process of rate normalisation – there’s no need for a fast start. Just like the European Central Bank (ECB) and the Bank of England (BoE), we expect the Fed to ease into the cutting cycle, with the ability to speed up if required. Like Cole Hocker in the 1500 metres, the Fed has the ability to catch the Europeans and Brits – before pulling ahead within time.

How far? Central banks aggressively tightened in the aftermath of 2021, and it has worked. Inflation is well below its peak and financial conditions are restrictive. It’s now time to normalise. For us, a global recession remains unlikely, therefore rates don’t need to become loose. We see the neutral rate for the US at approximately 3%, with 2% in the European Union (EU) and the UK probably closer to the US than the EU.

For clarity, the global economy doesn’t need to collapse to achieve the rate cuts above.

Are central banks going to deliver gold?

It’s fair to say certain central banks were too slow to move on the way up. We think the risk is that they are over-hesitant on the way down.

Markets want ‘further, lower, stronger’

(Further and lower referring to the level of rates. Stronger referring to the communication.)

Instead, the message from central banks so far has been:

‘Slower, later, vaguer’

The ECB committed to a cut in June and then seemed to regret the decision. The BoE delivered an uncomfortable cut in August, with four members (out of nine) voting to stay on hold. The Fed has signalled cuts are on the table…but we are now not far from the end of the third quarter.

For the ECB, growth and wages have surprised on the upside this year. That said, activity remains lacklustre at best, and wage pressures are moving lower. Slowing growth in the second half of the year should make the delivery of cuts less contentious for the hawks on the committee.

Over at the BoE, stubborn services inflation has clouded the argument. The Taylor Swift effect has given pun-favouring analysts lots of fun, but  it has caused difficulty for those of us looking at the numbers. Services inflation remains elevated, although it will continue to trend lower. Additionally, one of the key BoE Monetary Committee Policy hawks has left.

And the Fed? The jobs data gives them all the firepower they need to kick off the cutting cycle.

What have we done?

In January, we felt global yields had moved too low, so we positioned for higher yields

In April we felt yields had gone too high, so we positioned for lower yields.

This move lower – finally – makes sense. 

So, as we gear up for the Paralympics in September, we’re comfortable remaining long of government bonds. Our preference is the UK market, but we also see value in holding US Treasuries and European bonds.