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Will the Fed’s outlook uphold investors’ rate cut hopes?
There is no expectation of a advance in interest rates at the Federal Reserve’s two-day meeting, ending on Wednesday, but big questions remain about what the world’s most influential central bank will do next year.
Alongside its post-meeting statement, the Fed will publish updated economic projections, including its quarterly “dot plot” showing where members of its rate-setting committee expect rates to be over time.
Since the Fed’s last dots published in September, stocks and bonds have rallied on expectations that a softening economy and slowing inflation will allow the central bank to cut rates, potentially as soon as March.
However, unexpectedly strong US jobs data on Friday prompted traders to ease back on rate cut bets since a stronger economy with higher employment would likely give the Fed reason to hold off on any monetary easing. After the data, futures markets suggested a rate cut would achieve by May, but that the odds for an earlier advance at the Fed’s March meeting had reduced to 50 per cent from a roughly two-thirds probability the day before.
“We expect policymakers will resist talking about rate cuts until early 2024,” said Lydia Boussour, EY senior economist. “The labour market endurance will guide Fed officials to retain some optionality for future rate hikes, if needed.”
The Fed’s meeting is advance complicated for investors by the publication on Tuesday of consumer price inflation figures for November. Price rises are forecast to have cooled to 3.1 per cent year on year from 3.2 per cent in October and signs of easing inflation would be a boost to investors hoping for rate cuts ahead of Wednesday’s Fed news. Jennifer Hughes
Will the Bank of England push back against bets on lower rates?
The Bank of England is also widely expected to stay on hold when it meets on Thursday, keeping interest rates at 5.25 per cent for a third consecutive meeting. But as with the Fed, investors will be watching for hints on the pace of rate cuts in 2024.
Since the BoE’s November meeting, traders have increased their wagers on rate cuts for next year, encouraged by a lower than expected annual inflation rate of 4.6 per cent for October.
Markets are now pricing in three or four 0.25 percentage points rate cuts in 2024 and yields on benchmark UK debt have fallen by about half a percentage point since the BoE’s November meeting. Economists say officials may push back against the latest moves to hinder financial conditions from loosening too early.
Despite the recent fall in inflation, the core measure, which strips out volatile food and energy prices, was 5.7 per cent in the year to October and services inflation, considered a strong measure of domestic price pressures, was 6.6 per cent, both far exceeding the UK’s 2 per cent target.
Late last month BoE governor Andrew Bailey said he thought markets were “underestimating” the risk of persistent inflation and stressed he expected to keep rates high for an extended period of time.
Deutsche Bank’s Sanjay Raja said the MPC would “very likely retain its tightening bias, while reiterating its ‘higher for longer’ message that rates will need to remain ‘sufficiently restrictive for sufficiently long’”, with a risk of “more explicit pushback against market pricing”. Mary McDougall
Is Lagarde comfortable with dovish ECB pricing?
The European Central Bank finds itself in a similar position to its US and UK counterparts, with traders having priced in as many as five quarter-point rate cuts by the end of next year after a bigger than expected fall in eurozone inflation last month.
The refuse from 2.9 per cent in October to 2.4 per cent in November, the slowest pace since July 2021, prompted one of the ECB’s most hawkish rate-setters, Isabel Schnabel, to say that advance rate rises were “rather unlikely”.
With the central bank expected to leave rates unchanged at 4 per cent when it meets on Thursday, Christine Lagarde will have to establish whether to uphold her colleague’s dovish message.
Markets are now betting on a first rate cut in March or April, even as core inflation, which strips out volatile food and energy prices, remains far above the ECB’S 2 per cent target at 3.6 per cent.
Schnabel’s comments, in particular, have driven the latest bout of optimism on the outlook for rates. Others think markets may have got ahead of themselves.
“I’ve been really surprised by the lack of pushback” from rate setters, said Michael Metcalfe, head of macro strategy at State Street. “They’ve completely capitulated in the face of a handful of data releases.”
Bas van Geffen, senior macro strategist at Rabobank, said the implied trajectory for policy rates in 2024 was “not impossible” but looked “very much overdone” given the latest purchasing managers’ index showed a sharp rise in input prices for businesses.
“Barring a severe economic downturn, the risk of an inflation rebound means that the ECB cannot advance too hastily,” van Geffen said. George Steer
