Key Takeaways
- Financial markets have firmly decided that the ECB and the US Federal Reserve will begin cutting interest rates in June.
- The Bank of England is seen as a laggard. However, even here the odds are 50:50 for a June cut.
- The UK, Europe and US all have low unemployment and headline inflation is set to fall close to target.
- Wage inflation is too high and a problem for all, however.
- Longer term, short-term rates should settle below the consensus and below market pricing for all three.
Financial markets have firmly decided that the ECB and the US Federal Reserve will begin cutting interest rates in June. The Bank of England is now seen as the laggard though even here the market odds on a June cut are 50:50.
At a press conference last week, the President of the ECB, Christine Laggard came as close as she ever has to pre-committing to a rate cut several months ahead. Of course, things can change but she went out of her way to highlight June as a meeting where they might cut. The US rate setting committee has many voices but there has been a consistent message that they need to see several months of low inflation to begin cutting rates. That condition should be met in June, we think. This week’s US CPI number will provide support for that view.
Although the economies of the UK, Europe and the US have many differences, from a monetary policy perspective they share several common factors. First, unemployment is very low. Yes, Friday’s data showed an unexpected rise in US unemployment but at 3.9% it remains very low. A similar pattern is evident in the UK, while unemployment in the Eurozone is indeed at a record low.
Second, headline inflation is set to fall close to target in each case. In the June quarter, inflation is expected to be 2.2% in the US, 2.4% in Eurozone and 1.8% in the UK.
The third common factor is a problem: wage inflation is too high. Data this week should show a significant fall in UK wage inflation but it is still in excess of 5%, far too high to be consistent with sustained 2% inflation. A survey on jobs, recently published, shows a decline but other data are less comforting. US average hourly earnings were weak in last week’s data but that series is distorted.
The New York Federal Reserve has recently published a timely measure based on a more accurate index, showing the decline in wage in inflation may have stalled. The best guess is that wage inflation is running above 4%, still too high. There is a good chance that this will fall in response to low headline inflation and a slower economy but we shall see. The ECB are hampered by a paucity of data on wages but a measure they have constructed comes in at 4.5%, again too high to be consistent with their 2% target.
My best guess is that the consensus is right and we’ll get the first cut in June in Europe and the US, with a reasonable chance the UK goes too. Longer term, short-term rates should settle below the consensus and below market pricing for all three.
That represents a good background for both bonds and equities. Let’s hope I’m right.
