Time is not on Biden’s side
Key points
- Some ongoing softening in economic activity has been supporting the shorter end of the yield curve.
- Biden is under intense pressure to demonstrate his capabilities to a sceptical audience.
- A large Labour victory was long assured in the UK election, with the only uncertainty being the future for the Conservative Party.
- In Europe, all eyes remain on France, with political risk unleashed and a government in paralysis.
Long dated US yields rose at the start of the week, as concern around Biden’s plummeting poll ratings, in the wake of the recent presidential debate, led investors to price in a Trump victory and a Republican clean sweep, with a probability exceeding 80%.
Such an outcome would be fiscally expansive, with Trump committed to further tax cuts. As this scenario came into view, so the US yield curve bear steepened, on concerns that debt worries would lead investors to demand an increased term premia to hold longer dated assets.
Meanwhile, some ongoing softening in economic activity has been supporting the shorter end of the yield curve, with the market continuing to discount a probability around 70% for a first Federal Reserve rate cut in September. In this context, business confidence surveys have indicated a moderation in demand and a number of labour market indicators have also softened somewhat.
Later today, the upcoming payrolls report will be closely watched, as always. For now, there is nothing in the data which appears to suggest recessionary developments. Therefore, risk assets have been supported by a narrative that a gentle moderation in economic activity can open the door to lower interest rates, without too many adverse consequences.
Next week’s US CPI data will also be very important in assessing implications for future monetary policy. In this respect, market estimates have CPI dropping to 3.1% y-o-y in June, which would be welcomed by the FOMC, if these estimates prove accurate. However, there will be two further CPI prints for July and August, prior to the September FOMC meeting.
Moreover, we think that the recent downshift in CPI may stall during Q3, with inflation remaining stuck around 3%. In this context, we could see the Fed cut rates in September, if activity data continue to trend a bit weaker, but this is not a foregone conclusion.
From this standpoint, market pricing of a September easing, which stands around 70%, appears broadly appropriate in our view. In the short term, we would be surprised to see this implied probability rise much above 80% or decline much below 60%. In this way, the front end of the yield curve can be somewhat anchored as we move into quieter summer markets – barring a much more material data surprise.
Meanwhile, with pressure for Biden to step down coming from within an increasingly desperate Democratic Party, the past few days have seen a flurry of speculation, and then denial that the president is considering his withdrawal from the race. Procedurally, it may be difficult for the Dems to oust Biden at their upcoming convention, given his resounding win across the Primaries, unless he volunteers his resignation himself.
Without doubt, there is now intense pressure on Biden to demonstrate his capabilities to a sceptical audience, and it is easy to see this pressure continuing to build to a point, where he finds this hard to tolerate. The incontrovertible reality is that all of us lucky enough to live into our 80s will come to learn that our levels of mental sharpness and acuity will be in decline at that point. For some of us, that decline will be steeper than it is for others. Yet with the president unable to turn back the clock and grow any younger, it will be incredibly hard for him to shake the perception amongst voters that he is simply not fit to hold the highest office in the country for another four years.
Should Biden depart, Kamala Harris is the easiest alternative selection for the Democrats already on the ticket. However, conventional wisdom in Washington has tended to cast doubt on her abilities, and it is questionable whether the party will quickly be able to unite around a credible alternative candidate to replace POTUS.