Dear Investors,
FED may not be able to deliver the rate cuts markets expect – (11 Must Updates) BlackRock
Inflation coming down
Risk assets ended 2023 on an upbeat note as the Fed appeared to make a big bet on inflation coming down and growth only gradually slowing.
Markets interpreted the Fed’s messaging as a green light for aggressive policy easing. The end-2023 rally could keep going well into 2024 as inflation cools further.
The U.S. 10-year Treasury yield closed the year roughly where it started – at about 3.8% – masking a major round trip between 3.3% and 5%.
Soft economic landing is possible
Markets interpreted the Fed’s communications around a potential peak in US interest rates as opening the door to sharp rate cuts as inflation falls.
BlackRock expects inflation to ease close to 2% in 2024 as consumer spending normalizes from the pandemic and goods prices fall.
Markets pricing in a perfect outcome is a big macro bet.
A soft economic landing is possible, but the range of potential outcomes is wide in the new regime of greater macro and market volatility.
Fed may not be able to deliver the rate cuts markets expect
Falling US goods prices are dragging down inflation as pandemic-driven swings in spending unwind.
BlackRock thinks that inflation is set to rollercoaster back up near 3% in 2025 as the goods price drag fades.
They continue to see geopolitical fragmentation bolstering inflationary pressures in coming years, too.
That’s why BlackRock thinks the Fed may not be able to deliver the rate cuts markets expect, even with growth moderating as consumers exhaust their pandemic savings and government spending on defense and student loan forgiveness tapers off.
The big question for risk assets: when they might start to reflect this outlook in 2024.
Central Banks Update – (Monetary Policy) Franklin Templeton
Fed: an unexpected shift in tone
The Fed’s projected 75 basis points (bps) for 2024 may not be quite as aggressive as market expectations but given that the peak rate is now lower and rate cuts are more front-loaded, the Fed’s dovish bias is clear.
Whether the Fed was right to pivot so soon will depend entirely on the trajectory of inflation and employment. There has been very little in the incoming economic data over the last few months to warrant such an expansive change in the Fed’s narrative.
It is therefore premature to declare victory over inflation and signal rate cuts so soon. While Franklin Templeton still believes that cuts in the second half of 2024 make more sense, an earlier start to the easing cycle would not come as a surprise given the Fed’s sudden change in tone.
ECB: waiting for labor market data
The ECB continues to navigate the hiking pause begun in September and signaled that no turnaround will occur anytime soon.
In contrast to the Fed, the ECB pushed back against market expectations of imminent rate cuts as it seeks evidence of a sustainable normalization process of inflation.
Despite a quicker disinflation momentum in recent months, the focus on wage and profits data in the first half of 2024 implies that cuts earlier than the summer months remain highly unlikely and conditional only to an unexpected and severe economic downturn.
Bank of japan: crawling toward normalization
The BoJ maintained its ultra-loose policy as well as forward guidance at its December meeting, dashing market hopes that were scouting for some hawkish signals.
January is also when the BoJ will likely again revise its inflation projections upwards, indicating clearly that inflation is expected to hover above 2% for the next two years.
Given this backdrop, the BoJ to embark on policy changes this year, starting with a change to forward guidance and discontinuation of the yield curve control framework.
A possible policy divergence with the Fed will help the yen, but the BoJ’s crawling policy moves thus far has only added to uncertainty and volatility.