The Fed opens the door to rate cuts, Asian stock markets collectively reach all-time highs, and spot gold maintains its upward trend.

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Yesterday's mild inflation report, combined with more signs of a cooling labor market, drove a strong rally on Wall Street as the market speculates that the Federal Reserve will cut rates for the first time this year at next week's meeting.

On Friday, Asian stock markets broadly followed the overnight rally in U.S. equities. Boosted by optimistic expectations for AI-related earnings growth, both Japan’s Nikkei Index and South Korea’s KOSPI Index reached record highs. The Nikkei rose 3.7% for the week. U.S. Treasury prices climbed, with the 10-year Treasury yield briefly falling below the key 4% level. Gold prices surpassed their inflation-adjusted 1980 peak.

The Nikkei 225 closed up 0.9% at 44,768.12 points, renewing a record high. The Topix closed up 0.4% at 3,160.49 points. South Korea’s Kospi closed up 1.5% at 3,395.54, also hitting a record high.The S&P 500 rose 0.8%. The Nasdaq 100 climbed 0.6%.The Bloomberg Dollar Spot Index fell 0.3%.The euro rose 0.4% to $1.1737.10-year U.S. Treasury yields dropped 3 basis points to 4.02%.Spot gold rose 0.4% to $3,648.02 per ounce.West Texas Intermediate crude oil fell 2.2% to $62.25 per barrel.

Cooling jobs data outweighs inflation, clearing the way for rate cuts

The set of economic data released on Thursday paints a clear picture of the Federal Reserve's policy tilt. The sharp jump in initial jobless claims is seen as a clear signal that the labor market is “breaking.” Josh Jamner of ClearBridge Investments noted that for the first time in a long while, CPI data was overshadowed on release day by initial jobless claims, highlighting the Fed's policy focus is shifting to its “maximum employment” mission.

Seema Shah of Principal Asset Management commented, “Today’s CPI report was overshadowed by the jobless claims report,” and she believes the weakness in employment data will inject more urgency into the Fed’s decision-making. Tiffany Wilding of Pimco likewise observed that jobless claims data is the “more important news.”

Analysts broadly agree that while inflation data has not cooled completely, it is not hot enough to prevent the Fed from responding to a weakening jobs outlook. Ellen Zentner of Morgan Stanley Wealth Management said, “Right now, inflation is an important subplot, but the labor market remains the main story,” which paves the way for a rate cut next week and further easing thereafter.

Markets bet on multiple rate cuts this year, with differences in easing magnitude

With the door to rate cuts wide open, the market’s attention has shifted from “whether rates will be cut” to “by how much.” Futures market data shows traders see a 100% chance the Fed will cut rates by 25 basis points next week, and expectations of another two cuts this year have climbed to around 90%.

Skyler Weinand of Regan Capital expects the Fed to cut rates by 25 basis points next week and two more times over the remainder of this year. Krishna Guha of Evercore also believes the latest inflation data supports the Fed making consecutive cuts in September, October, and December.

However, there is some divergence over the scale of rate cuts. Tiffany Wilding of Pimco, while expecting a 25 basis point cut next week, notes the decision-makers “may discuss a 50 basis point cut.” But Seema Shah points out that, given jobless claims remain low compared to 2021 and economic activity and corporate profits show no signs of recession, the Fed may not need to pursue emergency-sized rate cuts.

Expectation of easing transmits globally, Asian markets hit new highs

The Fed's easing expectations are quickly transmitting globally through capital markets. Asian equities broadly followed Wall Street higher on Friday. Boosted by optimistic AI-related earnings forecasts, Japan’s Nikkei and the Korean KOSPI both hit historic highs. The Nikkei gained 3.7% for the week.

In contrast, the European Central Bank remains more cautious. The ECB left rates unchanged on Thursday, signaling its policy is in a “good place.” Currently, markets see just a 20% chance of the ECB cutting rates in December.

Elsewhere, the dollar fell back to 147.23 yen. In commodities, spot gold was steady near $3648 per ounce, still close to the record high of $3673.95 earlier in the week. Oil prices fell slightly as the International Energy Agency (IEA) forecasted a record oil supply surplus for next year, putting Brent and U.S. crude prices under pressure.

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