The data dependent nature of monetary policy has intensified the mutual influence between economic data, financial markets and central banks. Inflation releases play a dominant role given that central banks pursue an inflation target. In the United States, when CPI numbers are published, the change in the financial futures contracts on the federal funds rate has the highest correlation with the monthly change in core inflation. Going forward, Fed watching will consist of monitoring the inflation surprises -the difference between the published number and the consensus forecast- as well as the ensuing market reaction
GDP growth, inflation, exchange and interest rates
Recent communication by the Federal Reserve and the ECB has made it clear that the first cut in official interest rates is coming. Both central banks are saying the same -it depends on the data- but the ECB communication is more opaque than that of the Federal Reserve, which provides interest rate projections of the FOMC members (dot plot). In assessing how fast and how much the ECB might cut policy rates in this cycle, several approaches can be adopted. Based on the credibility of the ECB and plausible estimates of the neutral rate, it makes sense to use an assumption of a range between 2.00% and 2.50% for the ECB deposit rate as the end point of the easing cycle.
GDP growth, inflation, exchange and interest rates.
In the US, the latest Survey of Professional Forecasters (SPF) of the Federal Reserve Bank of Philadelphia paints a rather upbeat picture of the economic outlook. A similar survey of the ECB points towards a gradual pickup in growth this year. In both cases, the level of disagreement is low. This provides reasons to be hopeful about the economic outlook. However, the alternative scenarios are predominantly negative for growth and inflation, and some have totally different implications for the evolution of bond yields. This would mean that as time goes by and the likelihood of the different alternative scenarios evolves, bond yield volatility could be high.
GDP growth, inflation, interest and exchange rates.
There is a broad consensus amongst forecasters that Eurozone quarterly growth in real GDP will gradually pick up over the year on the back of a further decline of inflation, cuts in official interest rates, investments in the energy transition and those related to NextGeneration EU. Foreign trade may also play a role. Survey data of the European Commission and S&P Global have improved since the autumn of last year but their level remains below the historical average. Based on historical relationships, their positive momentum -recent observations are better than those 3 months ago- increases the likelihood that GDP growth in the first quarter will be better than in the final quarter of 2023.
After a short respite in December, uncertainty about US economic policy, based on media coverage, rose again in January. This resurgence in uncertainty was likely caused by the latest US inflation figures, which proved more persistent than expected: it remained above 3% in January (3.1% year-on-year, according to the BLS Consumer Price Index) and turned out to be higher than consensus expectations (2.9%). During its mid-December meeting, the Federal Open Market Committee (FOMC) made it clear that it would not be appropriate to cut rates in the absence of certainty as to whether inflation was on a sustainable downward path towards its 2% target.
Monetary and exchange rate conditions in emerging economies are more favourable in this early part of the year than they were at the end of 2022 and beginning of 2023. The relaxation of monetary policies made possible by lower inflation and upward revisions of economic growth forecasts has attracted portfolio investment. Despite the increase in geopolitical risk, sovereign risk is likely to reduce except for the most fragile countries, which were already under pressure in 2023. For low-income countries, 2024 will be a high-risk year as governments’ external debt repayments will remain very heavy, just as they were in 2023.
Against a backdrop of rising regional geopolitical pressures, the economic crisis is deepening further in Egypt and now poses a threat to public finances. With no agreement reached with the IMF, the balance of payments crisis is continuing to unfold, and the adjustments needed are being postponed. As a result of the exchange rate depreciating and interest rates rocketing, this crisis has pushed the interest burden on government debt to a level that could quickly become unsustainable. As a matter of fact, it could hit 70% of government revenue this year and remain very high next year
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
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
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.
