Having a good understanding of a central bank’s reaction function is important. It influences inflation and interest rate expectations, the level of bond yields, investor risk appetite and economic confidence in general. In the US, different types of information help to improve our understanding of the Federal Reserve’s reaction function: monetary policy rules -which play a prominent role in the material prepared by the Fed staff for the FOMC meetings-, the relationship between inflation, growth, unemployment and the federal funds rate in the Summary of Economic Projections of FOMC members as well as speeches and press conferences
GDP growth, inflation, interest and exchange rates.
Since a 1977 act, the dual mandate of the Federal Reserve (Fed) has de jure entrusted it with the objectives of maximum employment and price stability (the latter being expected to favour the former in the long term). However, these objectives can come into conflict and, as has been the case since March 2022, the Fed may have to give clear priority to reducing inflation at the risk of damaging employment and output. This refers to the concept of sacrifice ratio or trade-off, i.e. the expected cumulative deterioration of the latter to help bring inflation back to its target (2%).
Our central scenario of a Eurozone take-off and a US soft landing, confirmed by the latest available indicators, is characterised by an expected convergence in growth rates. This base case could, however, be impacted by political uncertainties on both sides of the Atlantic (uncertain outcomes of the early parliamentary elections in France and the US presidential election). Furthermore, while the ECB began its easing cycle in June, as expected, providing timely support for growth, the Fed is still holding back. This extension of the status quo, even if it seems justified for the time being, constitutes another downside risk. However, growth is benefiting from other supportive and resilient factors, chief among them real wage gains
Although we now know the results of the European elections, the implications of these results – in particular the outcome of the snap parliamentary elections in France – remain uncertain. Our central scenario of a Eurozone take-off and a US soft landing, characterised by a convergence of growth rates, could be weakened by political uncertainties on both sides of the Atlantic. However, growth is benefiting from tailwinds and factors of resilience, with real wage gains at the forefront. For the time being, the cyclical situation remains positive for the Eurozone: our nowcast estimates Q2 growth at +0.3% q/q. However, greater uncertainty surrounds the continuation of this recovery.
May’s activity data once again highlights the fairly different dynamics of the various components of Chinese economic growth. Overall performance is still somewhat lacklustre and points to a slowdown in activity in Q2 2024 compared with the previous quarter.
GDP growth, inflation, exchange and interest rates.
In recent weeks the guidance from several ECB Governing Council members had become increasingly clear that the June meeting would see its first rate cut in this cycle. Against this background, not acting was out of the question, despite the uptick in the latest inflation data.
Since 2022, South Africa’s external accounts have deteriorated. After two years of exceptional surpluses in 2020 and 2021, the current account has returned into deficit again since Q2 2022, due to the normalisation of trade terms and strong growth in imports (32% of GDP in 2022-23). At the same time, the financial account has not regained its pre-pandemic momentum so far. Net portfolio investment flows, which were close to 3% of GDP on average over 2010-19, have become negative since 2020, while net foreign direct investment (FDI) inflows have remained modest (1.5% of GDP on average over 2020-23).
Following the first rate cut at the June meeting of the ECB, the focus has now shifted to the timing and speed of further reductions in the deposit rate. The guidance is vague: decisions will be data-dependent. For investors, estimating policy rules -the relationship between past decisions and inflation and other relevant variables- has merits to get a better understanding. Such a rule shows the key role played by the difference between observed inflation and the inflation target. However, there are important caveats. The estimated rule implies a very slow adjustment of the deposit rate, which is difficult to justify when the ECB is in easing mode
On 5 June 2024, Eurobank Ergasias Services and Holdings, National Bank of Greece, Alpha Services and Holdings, and Piraeus Financial Holdings (in that order the first to fourth largest Greek banking groups by CET1 capital) were authorised by the European Central Bank to pay out a weighted average of 24% of their 2023 net income attributable to Equity Holders. This payout, totalling EUR 875 million, 93% of which is in the form of dividends, is the first of its kind since 2008 for these banks, which between them account for some 90% of the Greek banking system’s total assets.
As expected, the ECB has lowered its policy rate, despite the upward revision of the staff inflation forecast. In the US, the very strong labour market report for the month of May will probably make the Fed even more cautious in deciding on a first rate cut. Until we have resynchronisation -with both central banks being in rate cutting mode-, there should be more desynchronisation, reflecting a difference in the disinflation cycle in the US versus the Eurozone. There is concern that this might weaken the euro versus the dollar and possibly weigh on the ECB’s policy autonomy. Such fears are unwarranted
The massive monetary tightening policy undertaken by the Federal Reserve, starting in March 2022, in order to combat soaring inflation, has driven up mortgage interest rates. This sharp uptick in rates has in turn led to a significant deterioration in demand metrics of the US residential real estate market (notably mortgage applications and existing home sales).Nevertheless, the buoyancy of the US economy at the aggregate level and the healthy financial situation of households have prevented the housing crisis from turning into a systemic crisis. The surge in mortgage rates has also affected the existing home supply, prompting a lock-in effect which has led to an unprecedented divergence between new and existing home sales, which was although insufficient to support the whole market.
The ECB’s meeting on 6 June, as well as the statement and press conference that will follow, are very much awaited, not because the outcome is uncertain, but because it should mark the start of the ECB’s rate-cutting cycle. Some points to note.
Faced with a significant increase in official interest rates, companies have been surprisingly resilient. Can this last in an economy which is bound to slow given the ‘high policy rates for longer’ environment? The Federal Reserve’s latest Financial Stability Report gives some comfort based on a comparison of corporate bond yields and spreads to their historical distribution. Moreover, resilient earnings imply a robust debt-servicing capacity. Does this assessment hold in a stress test scenario? A recent analysis of the Federal Reserve concludes that the debt-servicing capacity of the U.S. public corporate sector as a whole is robust to sustained elevated interest rates, unless in case of a severe economic downturn
It is highly likely that this year the ECB will cut its policy rate before the Fed does. This sequencing has become a topic of debate amongst central bank watchers, as if the ECB would be jumping the queue and refuse to wait in line until the Fed has eased policy. Does it matter if the ECB cuts rates before the Fed? The answer is no.
In the US, in an environment of aggressive monetary tightening, the resilience of companies has contributed to the resilience of the economy in general through various channels -staffing levels, investments, growth of profits and dividends, etc.-. Companies’ resilience has been underpinned by different financial factors: company profitability, cash levels accumulated during the Covid-19 pandemic, the ease of capital markets-based funding, low long-term rates that had been locked in during the pandemic. Finally, the growing role of intangible investments also plays a role because they are less sensitive to interest rates, thereby weakening monetary transmission.
After being left reeling by the unexpected money market crisis during its first round of quantitative tightening (QT1), the Federal Reserve (Fed) intends to manage the reduction of its balance sheet better. This means destroying some of the reserves held by banks at the Fed without triggering a shortage in central bank money, given the liquidity requirements imposed on banks.
GDP growth, inflation, exchange and interest rates
The message following the FOMC meeting of 30 April-1May, was unambiguous. It will take longer than expected to reach the point of confidence on the inflation outlook that would warrant a cut in the federal funds rate. Consequently, we are back in a ‘high for long’ environment for the federal funds rate, like in the fall of last year. At the current juncture the key question is whether the economy can remain as resilient if the federal funds rate stays at its current level until the latter part of the year, or even longer, or whether the risk of a hard landing is increasing
In line with previous months, the recovery in the private sector credit impulse continued in the first quarter of 2024, after the dip seen in the third quarter of 2023. This said, the recovery was slightly slower than at the end of 2023 and the overall trend is still negative. Developments in lending to business are traditionally more volatile over the cycle than those in lending to households. Recent ones have not deviated from this rule: in the autumn of 2023, at a time when the effects of the tightening of monetary policy were at their strongest, the impulse of lending to households did not fall as far, in absolute terms, as that for lending to businesses. Conversely, its recovery since then has been less vigorous
The debate on monetary sovereignty in emerging countries is resurfacing with, on the one hand, the plan of Argentinian President Javier Milei to dollarise his economy, and on the other, the temptation of several West African country leaders to abandon the CFA franc. From a strictly economic point of view, dollarisation is effective in tackling hyperinflation. However, to be sustainable in the long term, it imposes severe constraints on fiscal policy and the nature of foreign investment. Conversely, the abandonment of the CFA franc with the aim of recovering the flexibility of an unpegged exchange rate regime and greater autonomy of monetary policy, is an argument that is either weak in theory or unconvincing in practice, even in the short term.
