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Optimism is cool again. Investors are in an ebullient mood after yesterday’s session saw a critical measure of services-sector sentiment top expectations, helping assuage recession fears and power equity indices to record levels. The dollar is softer, Treasury yields are steady, and several of the biggest US tech companies are sitting on market capitalisation gains bigger than most economies.

The Institute for Supply Management’s services index clocked in at its highest level since last August, suggesting that the biggest sector in the US economy remains in rude health. The headline index hit 53.8 in early May, above the 50 threshold that separates expansion from contraction, and well above economist forecasts that had been set closer to the 50.7 mark. Details under the hood pointed to “Goldilocks”’dynamics as well, with the prices-paid subindex retreating from 59.2 to 58, and employment falling from 50 to 47.1.

This morning, the European Central Bank will almost certainly become the second Group of Seven central bank to cut rates. Although inflation rates have recently shown signs of turning sticky, downward progress has been swift and a sustained move above target looks unlikely. Restrictive policy settings are holding key sectors back and growth remains fragile, but signs of life are appearing, with economic surprise indices now outperforming their US equivalents. Staff forecasts for price growth should remain steady, with the gross domestic product outlook revised slightly higher.

Market focus will be centred on the press conference, where Madame Lagarde may try to fight a rear-guard action against investors who expect a rapid cadence of rate cuts to unfold in coming months. A forceful emphasis on upside risks to growth and inflation could see the euro break through the 1.09 level to the topside. Alternatively, she may drop hints about a September move, forcing a consolidation in already-wide rate differentials and putting the common currency under renewed pressure.

Yesterday’s rate cut from the Bank of Canada had a relatively muted impact on markets. The Canadian dollar sold off almost 40 basis points in the moments after the decision was released, but fully reversed its losses over the next hour and is now trading near pre-decision levels. Swap markets saw modest moves as investors lifted bets on the next rate cut coming as soon as July – but the total number priced in for 2024 remained fairly static and US-Canada yield differentials held relatively firm.

Contrary to our expectations, policymakers avoided warning households and investors against assuming further cuts – an omission that raises the likelihood of a move at the July meeting. Governor Macklem said it would be “reasonable to expect further cuts to our policy interest rate,” and attached a couple of caveats that, to our ears, sounded fairly weak, suggesting that an easing in financial conditions is exactly what policymakers are attempting to engineer. If the data released over the coming seven weeks – two consumer price reports, two sets of employment numbers, a retail sales snapshot, another monthly growth report, several Bank surveys, and an update to internal forecasts – fail to bring evidence of an economic recovery, back-to-back cuts could become a real possibility.

Tomorrow’s non-farm payrolls number could make or break the market mood. The consensus estimate suggests 185,000 jobs were created in May after 175,000 in the prior month, with the unemployment rate holding at 3.9 percent and average hourly earnings rising 0.2 percent month over month. A print that undershoots forecasts could reinforce concerns surrounding a cooling in labour market conditions, potentially raising odds on a summer rate cut from the Fed, while an overshoot would help offset recession worries while bolstering earnings expectations.

But it would be surprising if the payrolls number wasn’t surprising. The initial estimate provided by the Bureau of Labor Statistics has repeatedly missed forecasts – on both sides – through the post-pandemic period, and there’s little to suggest that this month’s report will break the pattern. Market turbulence is fairly likely.

Euro Crisis Flashbacks Hit Markets
European political nerves
Market Calm Returns
US inflation vs the Fed
Fed Signals One Cut in 2024, Down From Three
US Inflation Decelerates Sharply, Bolstering Rate Cut Odds

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