GDP growth, inflation, interest and exchange rates
Faced with a natural disaster and a political crisis, 2024 is off to a rocky start for Japan. However, the economic impacts of the earthquake that struck the country’s west coast on 1st January 2024 are expected to be fairly limited due to the authorities’ effective preparations and quick response in dealing with this type of event. After an expected growth of +0.4% q/q in the fourth quarter of 2023, activity should slow in the first quarter of 2024, although it will remain positive at 0.2% q/q. The fall in inflation and bond yields at the end of 2023 is providing some breathing room for the BoJ, which is expected to end its negative interest rate policy in March or April
The narrative of the last mile of disinflation being the hardest, which in 2023 became popular in the world of central banking, reflects concern that after having dropped significantly, further declines in inflation would be more difficult.However, it seems that relevance of this narrative is increasingly being questioned. The account of the December 2023 meeting of the ECB governing council mentions that it has been debated. It seemed that the disinflation of 2023 had been faster than in previous episodes, raising doubts about the relevance of the narrative. A paper of the Federal Reserve Bank of Atlanta analyses this topic for the US. Based on recent research on the Phillips curve, it concludes that the ‘last mile’ is likely not significantly more arduous than the rest
GDP growth, inflation, exchange and interest rates.
In recent speeches and interviews, officials of the Federal Reserve and the ECB have cooled down market enthusiasm about the timing and number of rate cuts this year. In the US, the message is that there is no reason to move as quickly or cut as rapidly as in the past, considering the healthy state of the economy. In the Eurozone, despite the drop in inflation in 2023, there is still uncertainty about the inflation outlook, particularly due to the pace of wage growth. Moreover, there is also a concern that the easing of financial conditions -due to overly optimistic market assumptions about the policy rate path- would be counterproductive from a monetary policy perspective. Both the Federal Reserve and the ECB want to tread carefully in deciding when to start cutting rates
GDP growth, inflation, interest and exchange rates.
Croissance du PIB, inflation, taux d'intérêt et de change.
Further progress in terms of disinflation and the room this creates for central bank easing seem to be the only economic ‘certainties’ for 2024. What is left is a list of important questions that should be answered as the year progresses. What will be the pace and extent of rate cuts? Is there a risk of underestimating the impact of past rate hikes that still must manifest itself? What about the timing and strength of the pickup in growth in reaction to lower inflation and the start of policy easing? Is there a downside to the scenario of a soft landing in the US? The answers to these questions matter for the real economy but are especially important for financial markets and the policy rate expectations.
Almost one year ago, we labeled 2023 as ‘a year of transition to what?’ based on the view that inflation would decline, that official interest rates would reach their peak and a concern that the disinflation process could be bumpy. 2023 has brought us many surprises: the resilience of the labour market in the US and the Eurozone, the extent of monetary tightening, the risk appetite of investors. The biggest surprise was the growth performance of the US economy. Towards the end of the year, the changing message from the Federal Reserve -and to a lesser degree of certain ECB governing council members- with respect to the monetary policy outlook has brought us a another favourable surprise and a hopeful note for 2024.
GDP growth, inflation, exchange and interest rates
The latest communication from the Federal Reserve -the new projections of the FOMC members for the federal funds rate and the comments of Fed Chair Powell during his press conference- reinforce the view that the US economy should experience a soft landing, which should allay potential worries about the outlook for corporate cash flows and household income. Bond and equity prices rallied, reflecting a feeling amongst investors of ‘Santa Claus is coming to town’. The focus will now shift to the trickier part of the soft landing scenario: how fast and far will rates be cut? Another important question is when will bond markets start to anticipate the risk that the pick-up in growth that should follow from further disinflation and lower interest rates would quickly lead to new bottlenecks.
Updated data on GDP growth, inflation, interest and exchange rates.
The ECB's latest macroeconomic projections show fairly marginal downward revisions to inflation (headline and core) and economic growth for both 2023 and 2024, compared to the September forecast. With real GDP growth now foreseen at 0.6% on average this year and 0.8% next year, the ECB's projections are slightly higher than ours, currently at 0.5% and 0.6% respectively.
In a recent speech, ECB President Christine Lagarde said that when the financing needs of an economic transformation exceed the capacities of fragmented financial markets, developing a capital markets union becomes crucial. This is the point at which the EU has arrived. According to European Commission estimates, financing the energy and digital transition will require more than EUR 700 billion annually. One way of reducing capital market fragmentation is by lowering the cost of information gathering for investors, e.g. through the harmonisation and, where possible, simplification of standards and regulations. This would increase the risk bearing capacity of investors and lower the cost of financing for issuers
Latest data on GDP growth, inflation, interest and exchange rates.
Last October, an average of over USD 1,500 bn was traded daily on the Treasuries repo markets through the Fixed Income Clearing Corporation (FICC), USD 500 bn more than in October 2022. While transactions between FICC clearing members remained relatively stable, sponsored repo loans rose sharply.
Several central bankers have recently insisted that the ‘last mile’ in the marathon towards the inflation target may be the most challenging. After an initial swift decline of headline inflation on the back of favourable base effects due to lower energy prices, further disinflation may take more time. Corporate pricing power, inflation expectations and wage growth play a key role in this respect. By insisting on the ‘last mile’, central bankers probably want to avoid sounding too optimistic on disinflation. Otherwise, financial markets might price in early rate cuts, which would cause an easing of financial conditions in capital markets that would neutralize part of the monetary tightening
Updated GDP, inflation, interest and exchange rates data.
Monetary policy desynchronization between the Federal Reserve and the Bank of Japan (BoJ) has become huge. This has caused a significant weakening of the yen. Higher US yields have also exerted upward pressure on JGB yields, which in turn has forced a gradual adjustment of the BoJ yield curve control policy (YCC). Inflation developments in Japan increase the likelihood of a policy rate increase but policy normalization is a delicate task for domestic reasons as well as international spillovers. The BoJ has chosen a cautious approach, with very incremental steps, but in the meantime the yen has continued to weaken, creating the risk of a snapback once policy is tightened. Acting sooner rather than later seems to be the recommended route for the BoJ.
The tightening of euro-zone monetary policy, which began in July 2022 and carried on until September 2023, continued to curb demand for loans and dampen economic activity in the third quarter of 2023. The initial effects on core inflation have also been apparent since the end of the summer.
Data on GDP, inflation, interest and exchanges rates.
In the US and several European countries, gross public sector borrowing requirements are expected to remain sizeable and the reduction in the size of central banks’ balance sheets -quantitative tightening- complicates matters. The impact on bond yields will depend on the risk-bearing capacity of investors. Their ability and willingness to increase their exposure to duration risk depends on several factors: the existence or absence of strict duration risk limits in portfolios of institutional investors, risk aversion in reaction to recent bond yield volatility, uncertainty about the outlook for official interest rates, the correlation between bonds and equities, the balance sheet capacity of financial intermediaries
