Repricing continued in the rates markets this week as central bankers did little to talk rates back up. The market is currently pricing in the US short-term rates to fall below 4% by end of next year. In euro area, short-term rates are priced to approach the 2% mark late next year. Optimism about rate cuts arriving sooner rather than later has driven long-term rates lower and equities higher. The US 10y yield has fallen by more than 100bps from late October to below 4% and the S&P500 index is closing in on the all-time high levels.
We agree that rate cuts loom in the horizon but consider market expectations on the pace too optimistic. We also highlight that recent easing in financial conditions poses an upside risk to inflation next year. In this week’s meeting, the FOMC cut down its median forecast for core PCE in 2024 while also revising down the dots (now showing a total of 75bps cuts). After the meeting, we were happy to see our long-held call for the first Fed rate cut in March has now become market consensus. Yet, thereafter, we think the market is too aggressive in pricing the pace for cuts. See Research US – Fed review: Rising optimism, 13 December.
For the euro area, the market is fully pricing in the first rate cut by April which we think is premature. In the Governing Council meeting this week, the ECB made no changes on rates as expected but announced it would start scaling back its PEPP portfolio starting H2-2024. The staff economic projections saw a downward revision for 2023 and 2024 in GDP, inflation and core inflation, but Lagarde also highlighted that the cut-off-date for the forecast parameters was prior to the recent fall in rates, which means that growth and inflation could turn out higher. It is true inflation has decelerated faster than expected and December flash PMIs on Friday confirmed that EA economy is slowing down. Yet, we are convinced the ECB wants to see further evidence on core inflation and wage dynamics, and hence, we keep our call for the first ECB rate cut in June 2024. Read more on Flash: ECB review – A conditional push-back, 14 December.
Norges Bank was the major outlier this week in a string of monetary policy holds by other central banks, as also the BOE and SNB kept monetary policy unchanged. Unexpectedly, NB decided to hike its policy rate by 25bp to 4.50% and signalled a 20% probability for another hike. Following the hike, we postponed our first rate cut from March to June, but lifted the number of cuts for next year from 4 to 5. See Reading the Markets Norway – Surprise NB hike paves way for 5 rate cuts in ’24, 14 December.
Before Christmas, we still have the Bank of Japan meeting on Tuesday. There has been some speculation whether the BOJ would tighten policies next week. We continue to believe we need more firm conclusions on 2024 wage negotiations before they will feel confident to abandon yield curve control and raise the rate to zero. Next week is quiet on data front, but in the euro area, we are closely following any news from the EU Council regarding an extraordinary meeting about the new fiscal rules. Also, before Weekly focus returns from Christmas break, we will get euro area December inflation data 5 January. In China, focus will be on December PMIs in early January, and in the US, we will receive November PCE print next week, and the December jobs report before our next publication.
Full report in PDF.
