It had been widely anticipated that Fed chairman Jay Powell’s main challenge yesterday would be in trying to push back on the idea that the US central bank was ready to cut rates sharply over the next 12 months.
With the sharp fall in yields since November there was an expectation that the loosening in financial conditions might put the central banks fight against inflation at risk.
It was therefore quite surprising that yesterday’s statement and dot plots embraced that narrative, delivering an early Christmas present to the markets, returning the 2024 median for dot plots to 4.6%, back to where it had been in September, while forecasting core PCE to decline to 2.4%.
The US dollar sank, along with 2-year yields which fell 30bps to a 6-month low, gold surged back above $2,000 an ounce, and US markets pushed up to their highest levels this year, with the Dow posting a new record high, confounding market expectations of a hawkish pushback.
At the press conference Powell tried to give the impression that the Fed retained the option to hike rates again, however this message is rather undermined by the fact that the FOMC cut their dot forecasts as much as they did. The admission that the FOMC discussed rate cuts was also noteworthy.
If “higher for longer” wasn’t dead before last night, it certainly is now, and certainly makes the job of both the Bank of England, as well as the ECB later today that much harder in maintaining a hawkish bias, with European markets set to open sharply higher, and new record highs expected for the DAX and CAC 40.
Having seen the Federal Reserve leave rates unchanged yesterday its now the turn of the Bank of England and ECB to follow suit, as well as try to navigate the messaging of when they expect to start cutting them.
When the Bank of England took the decision to hold rates steady in September it was a close-run thing, but on the balance of risks it was also probably the right one given the challenges facing the economy as we head into year end.
These challenges have been thrown into sharper focus this week with wage growth slowing to 7.3%, and an economy that contracted by -0.3% in October. This week’s data has prompted markets to price in the prospect that the BOE will prioritise the UK economy over its battle against inflation, with yields dropping sharply to their lowest levels since June.
The emphasis in recent meetings to what has become a “Table Mountain” approach to rate policy, and a higher for longer approach does present some problems in terms of messaging especially when growth is slowing sharply however when looking at high levels of services and wage inflation it’s hard to see how the Bank of England can overlook that even against the currently challenging growth outlook.
Now that the energy price cap inflation is out of the headline numbers, CPI is now back at a more manageable level of 4.6%, well below last year’s peak of 11.1%, although core prices are still at a lofty 5.7%.
The Bank of England’s biggest concern however is wage growth which is currently at 7.3%, while services inflation is at 6.6%, and appears to be behind some of the dissent on the MPC amongst those who still want higher rates, although this number has shifted to 3 external members of Catherine Mann, Megan Greene, and Jonathan Haskel.
It will be interesting to see if they drop their dissent given this week’s economic data, and opt for the status quo today, with the markets also already pricing in some rate cuts for next year. These will still probably happen; however, they may not come as early as markets are currently pricing given current inflation levels.
When they do happen, they are likely to come well after the ECB starts cutting given inflation here in the UK is still over 2% higher than it is in the EU on an annualised basis.
This is the challenge facing the ECB today given that they were the central bank which raised rates as recently as September, and a dovish pivot today would surely be an admission that the ECB erred 3-months ago.
When the ECB met in October President Christine Lagarde said that risks to growth were tilted to the downside, but also that inflation was still too high, although it isn’t now given headline CPI for November is now at 2.4%.
At the time there was no commitment as to whether the ECB was done on the rate hike front, however that has now changed given recent comments from Germany’s Schnabel and France’s Villeroy.
Recent economic data coming out of Europe since June has been dire and we now know that the ECB governing council has been surprised at how quickly inflation has slowed.
Putting to one side that it shouldn’t be a surprise given the trend in PPI over the past 12 months a few other members of the Governing council, have also admitted that the next move in rates is likely to be lower in 2024.
That’s not surprising given that in Q3 the French economy slipped into contraction, and with Germany not having seen much in the way of growth this year markets are now pricing in rate cuts for as soon as April 2024.
It was also noteworthy that at the start of this month Villeroy said that rate hikes were over based on the current data, thus supporting the view that inflation was returning to target. That is already quite apparent with November CPI falling to 2.4%, having been at 5.3% only 3 months before.
No changes in policy are expected with the biggest challenge facing Christine Lagarde today being in convincing the market that rate cuts won’t begin much before the summer of next year, given how bad the economy in Europe already is.
EUR/USD – yesterday’s rebound pushed above the 200-day SMA this time opening the prospect of a move towards 1.0940. Support still above the 50-day SMA at 1.0720.
GBP/USD – held above the 200-day SMA at 1.2500 yesterday rallying strongly. A break below the 200-day SMA and 1.2460 signals a broader test of the 1.2350 area. Having broken resistance at the 1.2620 area could extend towards 1.2720.
EUR/GBP – breaking higher and heading towards the 100-day SMA at 0.8640. Support now at 0.8580.
USD/JPY – the US dollar slid sharply yesterday having run into resistance at 146.60, falling below 144.70, dropping below the 200-day SMA at 142.50, and could see a retest of the 140.00 area.
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