The Markets
At the last meeting, the Fed made an impressive U-turn from its 2023 approach. 2024 will be a different chapter for monetary policy. The Fed left its benchmark rate unchanged at 5.25%-5.50%. Another hike hasn’t been formally ruled out, but Chairman Powell’s press conference and the dots clearly signaled that the Fed is trying to figure out when it can start unwinding policy tightening. Inflation, including core, is cooling. This allows the Fed to shift its focus away from inflation and back to the two sides of its mandate, including growth and the labor market.
After a strong performance through the third quarter of this year, the economy is showing signs of slowing and the labor market, while still strong, is becoming more balanced. The dots see below-trend growth of 1.4% next year, down from 2.6% this year, returning to trend in 2025 (1.8%). Unemployment is seen ticking up to 4.1% (2024-26) from 3.8% currently. Slower demand will push PCE inflation to 2.4% next year and to 2.1% and 2.0% in 2024 and 2025, respectively. This combination will allow the Fed to make policy less restrictive.
The dot plot now “guides” 75 basis points of rate cuts by the end of next year. Admittedly, the dispersion of views was large. Nevertheless, the new direction of the Fed’s thinking is clear. Powell said that the Fed is well aware of the risk of overtightening. The Chairman also gave no indication that the MPC was uncomfortable with the recent easing of monetary conditions. A clear green light for recent market positioning and that is exactly what happened. US yields fell off a cliff as the bullish curve steepened. The 2y lost 30.4 bps.
The 10-y dropped 18.4 bps and is currently trading below 4.0%. The 30-y is still down 13.3 bps. Markets are now fully discounting a first 25 bps rate cut in March and a 1.5% easing late next year. Stocks flourished, with the Dow, S&P 500 and Nasdaq all up about 1.4%. The Dow even set a new all-time high. The dollar fell sharply (DXY 102.87, EUR/USD 1.0874), but in both cases remains above the late November lows. This was not the case for USD/JPY, which is now correcting (testing 141 this morning).
The focus today will be on the policy decisions of the ECB and to a lesser extent the Bank of England. As with the Fed, the “guidance” from the ECB staff projections and ECB President Lagarde’s assessment at the press conference will be key. So far, ECB policymakers have shown a more decisive “leaning against easing” bias than the Fed.
The question is whether the ECB’s inflation forecasts will be lowered enough for Lagarde and Co. to formally open the debate on rate cuts in 2024. Even if the ECB takes a more dovish approach, important spillovers from the US will hit European markets. If the ECB makes a less obvious U-turn than the Fed, a retest of EUR/USD 1.10 could be on the cards. We will also be looking for any communication on the start of the unwinding of the ECB’s PEPP bond portfolio.
News and Views
Australia’s November employment report crushed expectations, adding 61.5k jobs, well above the 11.5k expected. The participation rate hit a new record high of 67.2%. The increased pool of available workers caused the unemployment rate to rise slightly (3.9%), but it remains well below pre-pandemic levels of around 5%. The head of the Australian Bureau of Statistics’ labor division, Jarvis, concluded that “we continue to see employment growth keeping pace with high population growth through to 2023”. However, the strong labor report does little to offset the impact of yesterday’s Fed pivot on markets outside the US.
Australian swap yields found a floor shortly after the release this morning. They are currently down 1-3.1 bps. Following the Fed’s decision, money markets are now pricing in a first RBA rate cut in June, compared to yesterday’s September/November. The Aussie Dollar continues its (mainly USD-driven) rally, with AUD/USD now at its highest level since July (0.672).
New Zealand’s Q3 GDP unexpectedly contracted by -0.3% q/q versus expectations for a 0.2% expansion, bringing the annualized figure to -0.6% (consensus 0.5%). Q2 figures were also revised sharply lower (from 0.9% to 0.5%). The goods producing sector took the brunt of the slowdown (-2.6% q/q), while services still managed to eke out some growth (0.4%). The contraction suggests that the Reserve Bank of New Zealand’s tightening is really taking hold. The expenditure approach showed a decline in household spending (-0.6%) as well as exports.
The RBNZ has kept the benchmark interest rate unchanged at 5.5% since May, signaled the risk of another hike next year, and scheduled no rate cuts until mid-2025. But the markets aren’t buying it, especially after the Fed. The first cut is expected in May. The damage to the Kiwi Dollar is limited thanks to a weak USD. In fact, NZD/USD rebounded to its strongest level since July (0.623).
