Heightened market volatility persists regarding the potential for US rate cuts

Developments in the US over the past 24 hours, and the reaction of the markets to them, highlight just how nervous the markets remain over the prospect for the Fed being able to deliver any interest rate cuts this year.

This latest bout of nervousness began with the release of yesterday’s Conference Board’s (CB) consumer confidence index, which printed at 102.0 in May, comfortably higher than the April reading of 97.5 and well above the expected reading of 96.0. What made the number even more of a surprise was that it was at odds with the latest (May) confidence reading provided by the University of Michigan (UoM), which showed a sharp fall from 77.2 to 67.4, and undershooting the consensus expectation of 76.2. There are some reasons that possibly explain this better CB performance. US fuel prices have been drifting lower over the past few weeks, while equity markets have bounced back and recovered from the ‘wobbles’ seen over the second half of April. There has also been some modest move lower in US mortgage rates, as the financial sector has responded to Powell’s recent assertion that no further increases in interest rates are envisaged. And finally, when comparing the CB index with the UoM index, the former has been undershooting the latter recently, suggesting some element of catch-up in the latest number.

But even after yesterday’s jump, overall the CB index has only recovered around one-third of the ground lost since January (when it printed at 110.90) and is only now just hovering above the level seen last November. Clearly it is too early to suggest that we are seeing a deep seated improvement in sentiment. And with the outlook for the US economy starting to look more difficult than that seen last year – an expected weakening in the labour market, slowing US growth, fading consumption – it is hard not to expect the CB index to start heading lower again. But the markets appear to be focusing only on the immediate headline reading.

This assertion is given more weight by the reaction seen overnight to comments made by Fed Governor Kashkari, who said that more interest rate hikes could yet be seen before rates are cut, and adding that “many months” of data showing CPI definitively returning to target would be needed before a rate cut could be deemed appropriate. Even though Kashkari is not a voting member of the FOMC, his opinions carry weight, and the markets have combined them with yesterday’s stronger consumer confidence number to conclude that US rates are at real risk of staying higher for longer, with yields rising, stocks falling and the USD strengthening as a consequence.

The fact that a non-voting Fed Governor and a single piece of data can illicit such a response shows just how nervous and uncertain the markets are regarding the outlook for US rates. This Friday we have the publication of April’s PCE deflator figure, the Fed’s preferred gauge of inflationary pressures, and where the market is anticipating the core monthly reading declining to its slowest monthly pace of growth seen so far this year (around 0.2%), given the softer CPI and PPI reports for April. But with the current risk-averse Fed now data-dependent in terms of setting policy, the past 24 hours have shown that any nervousness its governors express regarding the outlook for inflation is at risk of triggering ordinarily unwarranted reactions in the markets. Clearly the outlook is for heightened volatility in the marketplace until that first interest rate cut is finally delivered.