A trader works as a screen shows a news conference by Federal Reserve Board Chairman Jerome Powell following the Fed’s interest rate announcement on the floor of the New York Stock Exchange (NYSE) in New York City on July 26, 2023.
Brendan McDermid | Reuters
The world’s major central banks have paused their cycles of rate hikes in recent weeks, and with data suggesting the economy is slowing, markets are turning their attention to the first round of rate cuts.
The US Federal Reserve, the European Central Bank and the Bank of England have sharply raised interest rates over the past 18 months to curb runaway inflation.
The Fed on Wednesday kept interest rates steady at a target range of 5.25% to 5.5% for the second straight day after ending a series of 11 rate hikes in September.
Although Chairman Jerome Powell was happy to reiterate that the Fed’s work to combat inflation was not yet finished, the annual increase in the consumer price index (CPI) was 3.7% in September, below the pandemic-era peak of 9, 1% in June 2022.
But despite Powell’s refusal to close the door on further interest rate hikes to finish work on inflation, markets interpreted the central bank’s tone as a slightly dovish turn and rallied on the decision.
According to CME Group’s FedWatch tool, the market is now narrowly pricing in an initial Fed rate cut of 25 basis points on May 1, 2024, with 100 basis point cuts now expected by the end of next year.
Since last week’s decision, U.S. nonfarm payrolls for October have been weaker than expected. Job creation was below trend, unemployment rose slightly and wages continued to decline. Although headline inflation remained unchanged at 3.7% a year in August-September, core inflation fell to 4.1% after roughly halving over the past 12 months.
“Core PCE, the Fed’s preferred inflation measure, is even lower at 2.5% (3-month annualized),” analysts at DBRS Morningstar noted.
“The lagged impact of a cooler property market is likely to reinforce the disinflationary trend over the next few months.”
But despite the dovish data points, short-term U.S. Treasury bonds reversed course on Monday and experienced a sell-off, which Deutsche Bank’s Jim Reid attributed to investors beginning to wonder “whether last week’s narrative about rate cuts was exaggerated.” The US economy is also proving to be more resilient than the UK and the Eurozone.
“For example, market pricing for the Fed now implies a 16% probability of another rate hike, up from 11% on Friday,” Reid said in an email on Tuesday.
“Furthermore, the interest rate priced in at the December 2024 meeting increased by +12.4 basis points to 4.47%. So there was a clear, albeit partial, reversal of last week’s measures.”
Reid also emphasized that this is the seventh time this cycle that markets have reacted particularly to expansionary speculation.
“Of course, interest rates won’t continue to rise forever, but on each of the last six occasions we have seen hopes of short-term rate cuts dashed. Note that we still have above-target inflation in every G7 country,” he added.
The ECB
Late last month, the ECB ended its 10 consecutive rate hikes to keep its key interest rate at a record high of 4%. Inflation in the Eurozone fell to a two-year low of 2.9% in October and the core interest rate also fell further.
The market is also expecting almost 100 basis points of cuts for the ECB by December 2024, but the first cut of 25 basis points is largely priced in for April, as economic weakness in the 20-member common currency bloc fuels bets that the central bank will be first , which is beginning to dismantle its restrictive policies.
Gilles Moëc, chief economist at AXA Group, said October’s inflation report confirmed and reinforced the message that “disinflation has become serious for Europe,” justifying the ECB’s “newfound caution.”
“Of course, the current disinflation does not exclude the possibility that a ‘resistance line’ will be found well above the ECB’s target. But confirmation that the euro zone flirted with recession last summer reduces that probability,” Moëc said in a research note on Monday.
After the October meeting, ECB President Christine Lagarde rejected the proposal to cut rates, but Greek National Bank Governor Yannis Stournaras has since openly discussed the possibility of a rate cut in mid-2024 if inflation stabilizes below 3%.
“This implicitly advocates a forward-looking version of monetary policy that takes delays into account to calibrate its stance. It is clear that waiting for inflation to reach 2% before cutting interest rates would be “excessive,” Moëc said.
“There is no doubt in our minds that the current flow of data clearly benefits the doves, but the hawks are far from giving up the fight.”
The Bank of England
The Bank of England left its key interest rate unchanged at 5.25% for the second day in a row on Thursday, after ending a streak of 14 consecutive rate hikes in September.
However, minutes from last week’s meeting reiterated the Monetary Policy Committee’s expectations that interest rates need to stay higher for longer, with the UK CPI holding steady at 6.7% in September. Still, the market on Monday priced in cuts of around 60 basis points through December 2024, albeit starting in the second half of the year.
Economists at BNP Paribas noted a “striking” addition to the MPC’s guidance on Thursday, saying recent forecasts indicated that “monetary policy is likely to need to be restrictive for an extended period.”
“Governor Andrew Bailey’s comments at the press conference suggested that this forecast was not intended as a pushback against the market-implied policy rate path underlying his most recent forecasts, which call for a 25 basis point cut only in the second half of the year 2024 is fully priced in.” They said.
“Instead, it should be noted that cuts are unlikely to be part of the discussion any time soon.”
In Thursday’s press conference, Bailey emphasized upside risks to the bank’s inflation forecasts rather than hinting at possible cuts.
“While we do not believe this necessarily indicates a high risk of further rate hikes in the near future, we interpret it as a further sign that the MPC is not and will not be considering rate cuts for a while,” BNP said Paribas added.
Source : www.cnbc.com