GDP growth, inflation, exchange and interest rates.
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
GDP growth, inflation, interest and exchange rates.
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.
This week's FOMC meeting followed by the statement and press conference on 1 May 2024 are eagerly awaited considering the change in tone from the Fed in recent weeks, which has signaled that rate cuts will come later than expected.
According to the IMF’s latest Fiscal Monitor, between 2023 and 2029, many advanced economies are projected to see an increase in their public sector debt to GDP ratio. The US ranks second in terms of increase of the public debt ratio (+ 11.7 percentage points of GDP). Administration and Congress will have no other option than to structurally reduce the budget deficit. However, the challenge will be huge given the unpopularity of tax increases, the difficulty of cutting expenditures and the major headwinds of rising interest charges and, in the medium run, slower GDP growth. Whether the US manages to bring its public finances under control also matters for the rest of the world, given the central role of the US Treasury market and the US dollar in the global financial system
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. 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.
Downward pressure on Asian currencies increased slightly last week, with the geopolitical and monetary climate becoming less favourable. This recent pressure has been fuelled by fears of rising international oil prices as a result of the conflict in the Middle East, on the one hand, and the shifting stance of the US Federal Reserve on the other. However, the Indian rupee has held up better than other Asian currencies so far.
Historically there is a very close correlation between changes in US Treasury yields and German Bund yields. This is relevant at the current juncture, considering that the recent hawkish twist in the tone of the Federal Reserve might continue to push US long-term interest rates higher and put upward pressure on bond yields in the Eurozone. However, since the start of the year, the increase in Bund yields is lower than expected based on the past statistical relationship. This probably reflects a conviction by investors that the ECB will start cutting its policy rate earlier than the Federal Reserve. This monetary desynchronisation is linked to a notable difference in terms of inflation with the US
News about growth, inflation and monetary policy influences bond and equity markets. For bonds, the relationship is straightforward but for equities, the relationship is more complex. Therefore, the correlation between bond prices and equity prices fluctuates over time. Since 2000 it has been predominantly negative, thereby creating a diversification effect. It underpins the demand for bonds, even when yields are very low. Unsurprisingly, during the recent Federal Reserve tightening cycle, the correlation has turned positive again. Based on past experience, one would expect that, as the Federal Reserve starts cutting rates later this year, the bond-equity correlation would turn negative again.
2024 should be the year of the start of the easing cycle by the Federal Reserve, the ECB, and the Bank of England, primarily to accompany the easing of inflation. However, the timing of the first cut remains uncertain, as does the number of expected cuts. Conditions for a first rate cut in June seem to be in place for the ECB, which, according to our forecasts, would thus act before the Fed, whose first rate cut is expected in July (instead of June previously). The possibility is rising that the Fed will not cut rates at all this year because of the resilience of growth and inflation. Such a prolonged Fed monetary status quo could have more negative than positive consequences.
US inflation March figure, again higher than expected, put an end to our scenario of a simultaneous first rate cut by the Fed, the ECB, and the BoE in June. We now expect only two rate cuts by the Fed this year, the first in July and the second one in December. The possibility is even rising that the Fed will not cut rates at all this year. On the ECB’s side, we maintain our expectation that the first cut will occur in June, but we have ruled out our back-to-back cuts forecast (i.e. June, July and September), favouring a more gradual easing of one cut per quarter (in June, September and December). The ECB would end up cutting rates before the Fed.
The Federal Reserve releases the Summary of Economic Projections (SEP) following the last meeting of the quarter. These forecasts are closely scrutinized as they include the “dot plots”, i.e. the median trajectory of the medium-term policy rate by the members of the Committee. The Q4 2023 projections included three rate cuts (of 25 bps each) in 2024, for a rate target of 4.6% at year-end. At the same time, the Fed Chair, Jerome Powell, noted progress on the inflation front (CPI at +3.2% y/y in Q4 2023, v. +7.1% y/y a year earlier), but refused to declare victory.
