The market panic appears disproportionate

The market's reaction following the recent US jobs report has been notably swift and intense. 

This morning, market volatility reached its highest level since the onset of the COVID-19 pandemic, highlighting an intensified global selloff. However, the market panic appears disproportionate. In our opinion, the core issue lies with the Fed being behind the curve, in action and in thought, rather than a significant economic downturn.

Currently, markets are pricing in a substantial 60 basis points (bps) of Fed cuts by September and an astonishing 140bps by the end of the year, equating to approximately 5.5 cuts of 25bps each. This seems like an overreaction, especially given the limited economic data and Fed communication expected this week. In fact, the ISM Services index rebounded back into expansionary territory (51.4) in July. Business managers noted “steady and stable” conditions despite lingering constraints from elevated costs and interest rates while the business activity, new orders and employment sub-indices all rose back into expansionary territory.

Many forecasters are abruptly marking their Fed forecasts to market, now predicting 50bps cuts in September (some even predicting back-to-back 50bps cuts), or even an inter-meeting cut.

In our view, the likelihood of three rate cuts this year instead of two has increased, and we now expect a 25bps rate cut in September, November and December. But it's crucial to remember the Fed's hawkish and inflation-wary stance if the economy does not deteriorate significantly. 

The primary concern remains the breadth and depth of the market selloff and its potential to tighten financial conditions, subsequently impacting the private sector and leading to economic retrenchment. This risk, exacerbated by the Fed's missed opportunity to ease in July, has always been a critical threat to the economy and grows more prominent as the Fed struggles to catch up.