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On Thursday 12 September, the ECB is widely expected by both analysts and markets to deliver a 25bp rate cut. The moderation in the labour market and economic activity since the June meeting should fuel confidence in the disinflationary process being on track, in particularly given the slowdown in wage growth.

We expect Lagarde to confirm that that it is entering the dialling back phase, but we do not expect a commitment to a specific timing of further rate cuts; thus, we do not anticipate that it will deviate from the meeting-by-meeting and data-dependent approach to the policy rate changes, thereby keeping its guidance's optionality and flexibility.

The updated September staff projection is expected to be largely unchanged, which is expected to lead to a cautious approach by the ECB. We will pay attention to the staff's projections on wages and productivity, on top of the inflation projection, in order to assess 'Lane's formula'.

Full report in PDF.

Summary

The services ISM notched a modest gain in August, quelling for now concerns about stalling growth. While the prices paid measure rose, the employment measure indicates a jobs market that is in a decidedly lower gear than it was as recently as earlier this year.

ISM Rises to Three-Month High

A run of lousy jobs market data has put the once all-but-assured soft landing in doubt, and while the services sector is not immune to the soft labor signals, activity there remains in good shape. In fact, it's improving. The ISM services index rose modestly to 51.5 in August, and while service-providers also face their fair share of challenges today, activity in the sector is merely moderating rather than declining as it is in wide swaths of manufacturing. That is giving way to a degree of measured...dare we say? optimism. (chart).

The select industry comments from purchasing manager respondents included mention of business being stable, good, strong or improving. Some others referenced high borrowing costs and elevated costs weighing on business activity, but the report remains consistent with an expanding sector, which quells some fear of stalling growth, for now.

Demand remains strong for services as new orders rose to 53.0 and eight industries reported an increase in orders in August (chart). Even as the measure of current conditions (business activity) pulled back in August, it remains consistent with expansion at 53.3 and only four of 18 industries reported a decline in activity last month.

For those parsing through the release on clarity of the jobs market, well it remains fuzzy. Sentiment was mixed as hiring continues in some industries while there are freezes in others.

It was the release of the July jobs report that sent financial markets into a tailspin just a few weeks ago. As the market awaits tomorrow's full jobs report for August, the employment component of the ISM services index declined to 50.2 (chart). That means essentially, in aggregate, job growth is flat. Layoffs and attrition are roughly matching new-hires. In reality, the details are more mixed. Some respondents mentioned hiring declines to control costs, while others mention it's hard to find talent even at a time when fewer jobs are available. This is not inconsistent with the separately reported slump in job openings reported yesterday.

Tomorrow's report is key in determining by how much the FOMC will slash rates at its upcoming policy meeting on September 18. We forecast a partial rebound in August hiring and reversal of the unemployment rate from July's increase. But if tomorrow's job report were to come in weaker than in July, a 50 bps reduction in the federal funds rate would remain the base case.

Inflation is still on the mind of policymakers, even if the labor market has garnered more attention. We'll get the consumer price index report next week for August, but the ISM services prices paid metric reported today rose in August to a three-month high of 57.3. That may not be problematic for policymakers. For many services companies the biggest cost is labor, so the cooling in the labor market may lead to continued improvement in service prices, a key indicator for the Fed in this cycle.

Fresh signs of a cooling labour market are boosting confidence in the Fed’s policy turnaround but have so far had a mixed effect on the dynamics of major markets.

The labour market is in the spotlight this week as it has the power to decide when and by how much the Fed will cut its key interest rate. The highlight will be the official Nonfarm Payrolls report on Friday, but important pieces of the puzzle will be assembled throughout the week.

Wednesday’s data showed that job openings fell to 7.67 million in July, the lowest since early 2021, against expectations for an increase from 7.91 million to 8.09 million. There was a historical peak of 12.2 million in March 2022, followed by a gradual normalisation. While the current readings look like a sharp drop from the peak, they represent a normalisation to the pre-pandemic peak of 7.5 million in early 2019.

ADP estimates released on Thursday showed that the private sector added 99K jobs in August, down from 111K the previous month. That’s the lowest level since the recovery began in 2020. US employment numbers have returned to the growth trend of the past fifteen years, climbing out of the hole created by COVID-19. It’s a clear slowdown but not necessarily a recession.

Weekly jobless claims also point to a slowdown in the labour market but not a recession. Initial claims fell to 227K last week, continuing a downward trend from a peak in July. Continued claims fell from 1860K to 1838K, against expectations for an increase to 1870K.

Apparently, the ‘most expected US recession’ is about to be renamed the ‘most expected’ recession. The big takeaway from the data is that there is still no need for the Fed to rescue the economy with a double cut in the Fed Funds rate. A 25-point cut in September, followed by a further assessment of the situation, looks like a much more prudent strategy for now. The Powell-led Fed has the chance to pull off a perfect policy reversal by smoothly lowering the rate to a neutral level, estimated at 2.8%.

On the other hand, with current growth rates lower than they were a quarter or a year ago, markets are betting on Fed dovishness with a 45% chance of a 50-point cut in September, up from 24% two weeks ago. Such a move could be a mistake, however, as it would confirm the risks of an overheating economy and lead to higher prices for commodities and services.

The ISM Services index was virtually unchanged in August, coming in at 51.5 from 51.4 in July, and virtually in line with the 51.4 expected. Like last month, ten of 18 industries reported growth for the month.

The business activity sub-index showed a slight deceleration in growth, but stayed in the black at 53.3, while the new orders index firmed up, rising to 53.0.

The prices paid sub-component ticked up again to 57.3 percentage points (pp) from 57.0 in July, but remains below its 2019 average. The supplier deliveries sub-index retraced some of last month's losses, rising 2.0 pp to 49.6.

The employment sub-component pulled back to 50.2, narrowly avoiding contraction territory.

Key Implications

The services sector continues to chug along. The details were pretty good, with the sole fly in the ointment being the slowdown in employment growth. All things considered, it's a relatively solid print given where we are in the business cycle.

While growth looks to be holding up pretty well, the Fed has been focused on labor market developments, leaving all eyes on tomorrow's payrolls report. Rate cuts are on the way, but with the economy continuing to rumble along, we expect the Fed will deliver 75 basis points of cuts by the end of the year.

Markets

The message from the July Fed meeting and even more from Chair Powell’s Jackson Hole address marked a U-turn in the Fed’s assessment. The focus shifted from taming inflation to preventing an unwarranted deterioration of the labour market. Markets are now in the process of finding out how fast the Fed will (have) to reduce policy restriction to allow the economy to keep creating enough jobs to avoid a further rise of the unemployment rate. Tomorrow’s payrolls are the key barometer. Data evidence earlier this week (manufacturing ISM, JOLTS) strengthened the case for the Fed to move fast and in bigger (50 bps) steps. The ADP private jobs report only added to the evidence of a labour market weakening. According to ADP, job creation in the US private sector in August was only 99K, the slowest pace since early 2021. The July figure was downwardly revised from 122K to 111K. On the other hand jobless claims declined slightly more than expected (initial claims 227k from 232k, continuing claims 1838k from 1860k). Still yields still drifted south with the US services ISM and tomorrow’s payrolls having the decisive voice in markets assessment. The US yield curve steepened slightly further ahead of the ISM (2-y -3.7 bps, 30-y -2 bps). German Bunds show a similar picture (2-y -3.5 bps , 30-y -2.0bps). Equities losses are far less sharp than was the case Tuesday. Still caution dominates. Investors pondering the impact of an economic slowdown prevents (US) equities indices to return near the peak levels that still were on the radar end last week. The Eurostoxx 50 is ceding 0.4%. US indices opened little changed, but especially the Nasdaq tries to reverse some of recent losses. Oil, a key pointer of market doubts on the global growth of late, stabilized near recent lows ($ 73.3 p/b). Headlines from people familiar with the internal debate within OPEC+ are flagging that the cartel is close to a delay in the scaling back of production caps. The rumours were confirmed in the meantime.

The Fed preparing a far more aggressive easing compared to most CB colleagues, is keeping the US dollar in the defensive, with especially the yen rivaling the greenback’s safe haven status. USD/JPY trades near 143.0 (from 143.74), closing in on the early August low. DXY struggles no to fall back below the 101 handle, with key support at 100.51. EUR/USD briefly jumped north of 1.11, but the single currency obvious also doesn’t play with strong cards. EUR/USD is returning intraday gains (1.109).

At the time of concluding this report, the US services ISM is reported little changed (51.5 from 51.4). Price paid rose slightly (57.3 from 57.0). Orders were OK (53.0), but labour momentum eased (50.2 from 51.1). It offers no reason for investors to change positions on the basis of this report going into tomorrow’s payrolls.

News & Views

Czech retail trade except of motor vehicles increased by 0.7% M/M and by 4.5% Y/Y (in real terms) in the month of July. Sales of food increased by 1.3% and for non-food goods by 0.4%, whereas sales of automotive fuel decreased by 0.1%. The Czech Statistical Office commented that the highest share in the year on year growth of sales in retail trade belonged to retail sale via mail order houses or via Internet and to retail sale in non-specialised stores with food, beverages or tobacco predominating. Sales for sale and repair of motor vehicles decreased by 0.8% M/M and by 2.1% Y/Y.

People close to Italian budget talks indicate that the Meloni government is aiming to reduce the nation’s budget deficit from around 4.5% of GDP this year to below the 3% deficit target by 2026 (2.9% of GDP). Finance Minister Giorgetti faces a September 20 deadline to come up with a budget plan. Other European countries face a similar deadline. The narrow deadline seemed difficult to make for France where a caretaker government is still in place since undecisive early July elections. Things might change rapidly though as president Macron today named EU brexit negotiator Michel Barnier as next premier. His first task is to form a cabinet to bridge views between the left, right and centrist blocs.

Graphs

USD/JPY: yen continues outperforming the dollar. Early August ‘stress-levels’ again within reach.

US 2-y yield extends decline below 3.85% support as 50 bps Fed cuts are becoming the more likely scenario.

Gold ($/oz): declining yields and economic uncertainty propel gold back near all-time record.

Brent oil: delay in OPEC+ output hikes slows decline, but nothing more than that.

US ISM Services PMI edged higher in August, ticking up from 51.4 to 51.5, in line with expectations. While the headline figure suggests continued expansion, some underlying components showed mixed results. Business activity and production declined from 54.5 to 53.3, and employment slipped from 51.1 to 50.2. On the positive side, new orders rose from 52.4 to 53.0, and prices paid by service providers increased from 57.0 to 57.3.

ISM noted that "ten industries reported growth in August," and that the Services PMI has expanded in 18 of the last 20 months since January 2023. The August reading aligns with the 2024 average for the index, standing at 51.5.

According to ISM, the relationship between the Services PMI and the overall economy suggests that the August reading corresponds to a 0.8% annualized increase in real GDP. This modest uptick signals ongoing, though limited, growth in the US service sector, which remains a key driver of the economy despite broader uncertainties.

Full ISM services release here.

USDJPY continues to trend lower and hit new one-month low on Thursday, pressured by expectations of Fed rate cut, diverging policies of Fed and BoJ (US central bank is heading towards its first rate cut, while BoJ started its tightening cycle and with hawkish signals from top officials).

In addition, weak US labor data (today’s ADP report showed that private sector hiring dipped well below expectations in August, while JOLTS job openings report was slightly above consensus, but overall picture remains weak).

Yen was also boosted by safe haven buying on uncertain economic situation in the US and persisting geopolitical tensions.

Fresh leg lower generated negative signals on Wednesday’s return and close below falling 10DMA (144.77) and violation of supports at 143.50/44 (Fibo 76.4% of 141.68/149.40 / former higher low of Aug 26).

Close below these levels is needed to confirm signal and open way towards targets at 141.68 (Aug 5 spike low) and 140.48/25 (Fibo 61.8% of 127.22/161.95 / Dec 28 trough) in extension.

Markets shift their focus to the last but the most significant report from the US labor sector – Nonfarm payrolls (Aug 164K f/c vs 114K in July).

Another miss on Friday, although ADP report is not seen as indication for the NFP, would confirm signals that the US labor sector is slowing down, which would add to narrative about possible more aggressive action by the Fed and increase pressure on dollar.

Res: 143.90; 144.63; 144.77; 145.54.
Sup: 142.84; 141.68; 140.48; 140.25.

Daily Pivots: (S1) 1.1048; (P) 1.1071; (R1) 1.1107; More....

Focus is now on 1.1104 minor resistance in EUR/USD. Firm break there will indicate that pull back from 1.1200 has completed at 1.1025, and bring further rise to retest this high. However, break of 1.1025 will extend the correction from 1.1200 instead.

In the bigger picture, prior break of 1.1138 resistance indicates that corrective pattern from 1.1274 has completed at 1.0665 already. Decisive break of 1.1274 (2023 high) will confirm whole up trend from 0.9534 (2022 low). Next target will be 61.8% projection of 0.9534 to 1.1274 from 1.0665 at 1.1740. This will now be the favored case as long as 1.0947 resistance turned support holds.

Daily Pivots: (S1) 1.3108; (P) 1.3141; (R1) 1.3183; More...

Intraday bias in GBP/USD remains neutral as consolidation from 1.3265 is still extending. While deeper retreat cannot be ruled out, downside should be contained above 1.3043 resistance turned support to bring rebound. On the upside, above 1.3265 will resume larger up trend to 100% projection of 1.2298 to 1.3043 from 1.2664 at 1.3409. However, firm break of 1.3043 will indicate short term topping and turn bias back to the downside for deeper pullback.

In the bigger picture, up trend from 1.0351 (2022 low) is resuming. Next target is 38.2% projection of 1.0351 to 1.3141 from 1.2298 at 1.3364. For now, outlook will stay bullish as long as 1.2664 support holds, even in case of deep pullback.