It has been a busy week of news flow, much of which has reinforced the current narrative around the path for monetary policy, with interest rates set to stay on hold for an extended period
In the US that’s thanks to a strong economy and sticky inflation, while for the eurozone, easing inflation pressures leave the door wide open for a rate cut from the European Central Bank next month. The messaging from the Federal Reserve reaffirmed the need to maintain rates given the inflation backdrop.
The Federal Reserve meeting, which concluded on Wednesday, delivered no change to interest rates as expected. This meeting was much more about the messaging and how the Fed would react to what has been difficult month in terms of various inflation and wages data surprising to the upside. The Fed signalled interest rates are likely to remain higher for longer, noting “a lack of further progress” towards their inflation goal in recent months. Fed Chair Jay Powell said the news conference “it is likely to take longer for us to gain confidence that we are on a sustainable path down to 2% inflation…. I don’t know how long it will take”. Powell said that high rates would “need more time to do their job” but indicated policy was already tight enough – “I think it’s unlikely that the next policy rate move will be a hike…. this would require persuasive evidence that our policy stance is not sufficiently restrictive”. Powell also acknowledged other central banks will be able to cut rates sooner than the Fed with “the difference between the US and other countries that are now considering rate cuts is that they’re just not having the kind of growth we’re having. We actually have the luxury of having strong growth and a strong labour market, very low unemployment, high job creation, and all of that; we can be patient and we’ll be careful and cautious as we approach the decision to cut rates.” Markets seemed relieved the Fed wasn’t more hawkish – Fed Fund futures actually pointed to a slightly higher potential for monetary easing towards the end of the year, with December seen as the most likely date for a rate cut.
It has also been a busy week in UK politics with the local and mayoral elections held yesterday delivering a poor set of results for the government, as expected. The full details will unfold over the course of the day, but the expected gains for Labour and corresponding losses for the Conservatives are coming through in the results so far at the time of writing (7am Friday morning). In the lead up to the elections there was some Westminster chatter about a general election taking place sooner rather than later. Divisions within the Conservative Party and questions over Rishi Sunak’s leadership may well increase as a result of the election results but the expectation remains the Prime Minister will continue to hold out for an election much later in the year. We have also seen political upheaval in Scotland with First Minister Humza Yousef stepping down ahead of an expected no-confidence vote. This came about as a result of the collapse of the power sharing agreement between the Scottish National Party and the Green Party.
The economic data in the US continues to point to inflationary pressures reaccelerating, with the disinflationary trend of the past year having firmly come to a halt. The latest data point to highlight these trends was the Fed’s preferred measure of wage growth, the Employment Cost Index climbed by 1.2% in the first quarter of the year, accelerating from 0.9% in the final quarter of 2023 and fastest pace in 12 months. The news sent the S&P500 index to its worst day since January as the market gets comfortable with the continued strength of the US labour market meaning that there is no justification for the Federal Reserve to cut rates in the near term; indeed there is the potential for no cuts at all this year; a huge contrast to just 4 months ago when market pricing pointed to six rate cuts in 2024.
Data from the eurozone was much easier to digest for markets, with inflation and economic growth both heading in the right direction. Eurozone growth for Q1 was reported at 0.3% ahead of the 0.1% expected and accelerating from the declines of 0.1% seen in Q3 and Q4 2023. Q1 growth was the strongest pace of growth since Q3 2022. Inflation data showed eurozone CPI at 2.4% in April, unchanged from March but core inflation fell back to 2.7% in April from 2.9% in March. Francois Villeroy, Governor of the French central bank said the data gives the European Central Bank confidence to cut rates next month, saying “we’ll return to our inflation target between now and year; we’ll therefore be able to start cutting rates in June” before “continuing to loosen policy at a pragmatic pace”. Quite a contrast to the relative hawkishness from the Federal Reserve.
The economic data (and recent Federal Reserve speeches) should make it abundantly clear to market participants for now that in the US at least rate cuts are highly unlikely in the near team. US inflation is not coming down quickly enough and the economy, notwithstanding the weaker than expected Q1 GDP print, is still in solid shape. Corporate earnings at the headline level look robust, though there is a skew towards the mega cap companies performance masking weaker numbers elsewhere. So, the outlook for markets points to some uncertainty, not least given the strong run we have seen since October. Bond markets are yet to get comfortable with the thought of US rates staying on hold, maybe until next year, while equities have so far, despite a mild pullback, shown more resilience. We expect a slightly more volatile environment, with markets laser-focused on inflation related data points and central bank language in the near term.
So, where do we go from here? Firstly, it is worth reiterating the Fed is not cutting rates because the US economy is still growing strongly with consumers still spending. The labour market remains solid. This contrasts with the UK and eurozone, where labour markets are also in decent shape but economic growth, while positive, remains tepid and importantly inflation continues to ease. In the US there are some hairline cracks in some data; the PMI data this week was disappointing and job openings are declining but the disinflationary trends have ended and short-term calculations on inflation are re-accelerating. While the Fed has ruled out rate hikes, they certainly cannot cut rates against this backdrop. Financial markets have come to terms with the fact that US rates are staying higher for longer, but this acceptance means market momentum has stalled, and we expect a somewhat more volatile period in risk assets as investor sentiment continues to be buffeted by the latest headlines on economic data and commentary from the Federal Reserve.
Enjoy the Bank Holiday weekend,
Regards,
Anthony.
Source: Columbia Threadneedle Investments as at 03-May-24
