Don’t rush too far ahead!
This quote from one analyst sums up the current situation very well indeed: “Policy-makers do not want rate cut expectations to become too far advanced, and so will generally try to suggest restraint, but the general principle of peak rates seems established”.
A stream of economic data across all the major economies suggests that activity has peaked in the autumn and looks set to slow into 2024. Starting with the strongest economy, after US GDP surged in Q3 the prospects are for a return to more moderate growth in Q4. Investors always pay close attention to the monthly employment report, as it provides so much information about the direction of the economy and inflationary pressures. The Fed must be pleased with October’s report. Unemployment edged up again, as payrolls rose by a smaller amount than in previous months, whilst the pace of wages growth looks to have slowed from 5.3% in Q2 to 4.4% in Q3.
As this slowdown was priced in, so US benchmark bond yields have fallen back, from a peak of 5% in early October to only 4.6% this week. The Federal Reserve has pushed back against such a development, but not too vociferously. As Jerome Powell said “The Federal Reserve is committed to achieving a stance of monetary policy that is sufficiently restrictive; we are not confident that we have achieved such a stance”. Christopher Waller described Q3 GDP as a “blowout” that warrants “a very close eye when we think about policy going forward”. Neel Kashkari agreed that it’s too soon to declare victory over inflation. “We need to let the data keep coming to us to see if we really have got the inflation genie back in the bottle so to speak,” Patrick Harker said the central bank’s decision to hold rates at its last meeting was the right decision, and reiterated that now is the time to take stock of what it has already done. All in all, the Fed’s view appears to be – keep policy on hold and await developments.
There are definite signs of weakness in the UK and Europe. UK services output fell slightly last month, and the sector continues to skirt with recession. The Recruitment and Employment Confederation reported that the number of permanent job placements fell last month, while growth in starting salaries for permanent staff was the slowest since March 2021. It is no surprise that the Bank sees CPI inflation coming down steadily in 2024-25, as its forecasts show unemployment rising all the way into 2026.
Markets were surprised at some mixed views from the Bank of England about next steps. The Bank’s Chief Economist, Huw Pill, caught the headlines when he indicated that he considered the markets were correct to be considering rate cuts in the second half of 2024. He then pulled back by stating that holding interest rates at their current level will be enough to bring inflation down to 2% within two years. This was more in line with the Governor Andrew Bailey, who said he is “optimistic” that inflation will come down to normal levels, but warned that the cost of borrowing must stay high for some time to come. The current profile for interest rates baked into the money markets is a one-in-three chance of another rate in this cycle, then the first rate cut possibly in May, more likely in August, and 1% lower by autumn 2025.
The ECB is trying to sound hawkish. Isabel Schnabel said the central bank is on track to push inflation back down to 2% by 2025, but the “last mile” of disinflation may be the hardest so the bank cannot yet close the door to the possibility of further rate hikes. Joachim Nagel also said it’s “not helpful” and “much, much too early” to discuss cuts. Such talk comes against the backdrop of a Eurozone economy which looks at best to see stagnant growth into the winter. Retail sales fell again in September, meaning that spending in the third quarter is on course to be down about 2% annualised from the previous quarter. As with the UK, economists are forecasting minimal growth or modest recessions into 2024.
Potential pitfalls lie ahead – for example the impact of Middle East troubles on oil prices, or the possibility of another US government shutdown if Congress cannot agree on the debt ceiling – but otherwise ‘talk tough and monitor the data remains the requisite approach for most central bankers’.
Bond yields at the time of writing
% 10 year Weekly Move
USA 4.62 -0.04%
UK 4.28 -0.11%
Germany 2.66 -0.06%
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making