A very busy week in markets, with two major central bank meetings, many companies reporting quarterly earnings and the IMF updating its forecasts for global growth
Let’s start with the central banks. The US Federal Reserve and the Bank of England made no changes to their policies, but they did provide useful guidance regarding the timing of rate cuts – in summary “not quite yet”. The Fed, as expected, kept rates on hold, but pushed back on market expectations for a rate cut in March, saying that “the committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably towards 2%”. Chair Jay Powell spoke positively about the progress made so far but said there was a need to have more confidence on the disinflation path, with the Fed “not looking for better data, but a continuation of the better data” that has already been seen. Powell said that a March cut is “probably not the most likely case”, adding “I don’t think it is likely that the committee will reach a level of confidence by the March meeting”.
Futures markets are pricing only a 35% probability of a cut in March – though the Fed will have two more inflation data points to digest by then. Powell’s comments suggest that if inflation remains on track, then even if March is not likely, rate cuts are coming soon. But the disappointment on a March cut was reflected in a poor day for US equities, not helped by bad news from a US regional bank – New York Community Bancorp – which served to remind investors of the potential unrealised losses yet to come as a result of the weakness in the commercial real estate sector which is highly leveraged and yet to adjust for the realities of post covid work practices, which have left a lot of buildings redundant.
The Bank of England left rates on hold at 5.25% as expected. There was a split vote in the Monetary Policy Committee (MPC) with 6 of the 9 members voting to hold rates, 2 voting for a 25bps hike and 1 voting for 25bps cut. The Bank’s inflation forecast shows it expects CPI to “fall temporarily” to its 2% target in the second quarter before increasing in the remainder of this year. CPI is expected to be above target in H2 2024 and 2025. There were hints in the statement of a shift to cutting rates, with the summary dropping an earlier explicit tightening bias, removing the warning that “further tightening” of policy might be needed. The statement now says that the “MPC remained prepared to adjust monetary policy as warranted and added that it “will keep under review for how long Bank Rate should be maintained at its current level.”
Governor Andrew Bailey said they “need to see more evidence that inflation is set to fall all the way to the 2% target, and stay there, before we can lower interest rates”. Bailey noted that the MPC “won’t leave Bank Rate on hold any longer than we need to” but they remain concerned about service price inflation and the impact of falling energy prices in the coming months. Markets are pricing a May rate cut at a 62% probability, down from 77% before the meeting. There was little change to market pricing for 2024 as a whole, with 110 basis points of rate cuts expected by December.
The economic numbers showed that the eurozone managed to narrowly avoid a technical recession in the second half of 2023 as GDP data for Q4 showed growth stagnating rather than the 0.1% decline expected. Year on year growth was +0.1%. A contraction in Germany and stagnant growth in France was offset by stronger growth in Italy and Spain, which was sufficient to see the currency bloc avoid recession overall. All the same, growth remains mediocre, and the lack of momentum in the economy will add to expectations that the European Central Bank will be cutting rates soon, not least when short term measures of inflation over three and six months are back at the ECB’s target.
The IMF updated its world economic outlook this week and upgraded its forecast for 2024 where they now see the global economy growing by 3.1%. This contrasts with its previous forecast of 2.9% made last October. The organisation forecast 2025 growth to be 3.2%; this remains below the historical average of 3.8% between 2000-19. The IMF noted the likelihood of a “hard landing” receding with steady growth and inflation easing but mentioned that downside risks remain not least with elevated geopolitical risks and continued concern over the impact of the property market woes on the Chinese economy.
To the upside, the IMF stated that the speed of the fall in inflation could lead to an easing in financial conditions, and that looser fiscal policy could be beneficial to growth in the short term, although bringing risks of a more costly adjustment in the longer term. The IMF predicted the UK to grow at 0.6% in 2024, with the eurozone seeing growth of 0.9%. China is expected to grow at 4.6% with India seeing growth of 6.5%. The US economy, boosted by fiscal spending with potentially more to come as President Biden tries to secure re-election, is expected to grow by 2.1%. Overall, with advanced economies expected to grow by just 1.5%, emerging and developing economies, expected to grow by 4.1% will do the heavy lifting in terms of driving global growth.
IMF Chief Economist, Pierre Olivier Gourinchas, welcomed the easing in inflation but noted that a substantial share of recent disinflation has been from a decline in commodity and energy prices. He argued that interest rate hikes have still played a significant role by convincing consumers and corporates that high inflation would not be tolerated, preventing inflation expectations from persistently rising, thereby dampening wage growth and lowering risks of a wage-price spiral. Gourinchas noted that central banks now face two sided risks in avoiding premature policy easing but equally making the pivot to policy normalisation at the right time, to avoid growth and inflation falling below target. He also argues that, when the time is right, fiscal consolidation is needed, to address the growing debt burdens, and give governments fiscal bandwidth to address future crises.
Geopolitical risks remain in the headlines, with the focus on the Middle East as ships continue to avoid the Red Sea and the Israel-Hamas conflict continues. We have also seen other incidents that threaten to unsettle the wider area, not least the drone attack on a US military post in Jordan that killed three US soldiers and injured many more. The attack was reported by the US as being carried out by “radical Iran-backed military groups”. President Biden said that the US would “hold those responsible to account at a time and manner of our choosing”. US Secretary of State Antony Blinken said “this is an incredibly volatile time in the Middle East… I would argue we have not seen a situation as dangerous as the one we are facing now across the region since at least 1973”. Referring to the attack on US troops, Blinken said the US wanted to “prevent broader escalation” but added “we will respond, and that response could be multi-levelled, come in stages and be sustained over time”.
Alongside the Fed meeting this week, there was also an important update from the US Treasury, who announced their funding needs for the coming quarters and also what type of debt would be issued to meet those needs. Bear in mind that the previous announcement last November lit a fire under risk assets, removing some significant stresses in bond markets as the US Treasury shifted to short term borrowing, reducing an overhang of longer-term debt issuance that was weighing on markets. The US will borrow an eye watering $760 billion in Q1 – this was received positively given that a level of $816 billion was expected – and “only” $202 billion in Q2. This implies an improvement in the trajectory of the budget deficit and only limited additional fiscal largesse as the US approaches the next election. The size of the US deficit remains an issue for another day as far as US politicians are concerned, though the numbers should be alarming. The budget deficit for 2024 is expected to be 5.8%, with debt now at 100% of its GDP, up from 76% in 2016. According to US research firm Strategas, it took roughly 232 years for the U.S. to amass its first $10 trillion in national debt, nine years to amass its second $10 trillion, and a mere five years to amass its third. The last trillion was added in less than four months.
