Markets navigated a week heavy with event risk with relative calm. US and European equities lifted but Asia underpeformed. The USD found support despite soft data reaffirming expectations for further Fed rate cuts. An easing Fed sets up central bank divergence as one of the key themes as markets look ahead to 2026. This week, the Bank of England cut by 25bps but the Bank of Japan hiked by 25bps. The ECB held steady as it continued to indicate rates had floored for the cycle, and the Riksbank and Norges Bank were also unchanged. Domestically, speculation is starting to increase around the RBA hiking as early as the February meeting.
US data slowly coming back online is supporting dovish pricing for two Fed rate cuts next year, with the labour market weakening and inflation slowing. Headline CPI eased from 3% to 2.7%yr, defying the 3.1% consensus while the core rate came in from 3% to 2.6%yr against expectations for no change. Cooling inflation reaffirms the Fed's focus on the employment side of its dual mandate, which showed renewed signs of weakness.
November payrolls rose by 64k but only after estimates reported a 105k fall in October. There were also 33k of downward revisions to payrolls in August (-26k) and September (108k). Given the Fed's view that the data are overstating payrolls by some 60k per month, all indications are that employment has been weakening into year-end.
The unemployment rate rose to 4.6% in November from 4.4% in September (no figure was posted for October), while the underemployment rate jumped from 8% to 8.7% - both measures touching highs back to 2021. That came as participation picked up to 62.5% and the prime age rate held at 83.7% - just 0.2ppt off cycle highs.
A widely expected hold from the ECB and upgrades to the growth and inflation outlook reaffirmed the pre-meeting view in markets that the easing cycle has likely run its course. The key depo rate was left at 2%, unchanged since June after 8 cuts from mid-2024 halved it from a peak of 4%. Swaps pricing has rates remaining on hold well into next year, the most likely scenario according to a Reuters article quoting ECB sources - though further easing has not been ruled out amid an uncertain economic outlook.
At the post-meeting press conference, ECB President Lagarde continued to describe policy settings as being 'in a good place', reflective of new forecasts that showed inflation is on track to stabilise around its 2% target. While the ECB lifted its inflation forecasts for 2026 to 1.9% in headline terms (from 1.7%) and 2.2% on an underlying basis (from 1.9%), it expects inflation to ease back in 2027 to 1.8% headline (from 1.9%) and 1.9% core (from 1.8%).
The uplift to the inflation outlook comes as the euro area economy has remained resilient to trade and geopolitical headlines, underpinned by services-led growth. Accordingly, the ECB also revamped the expected growth profile to 1.4% this year (from 1.2%), 1.2% in 2026 (from 1%) and 1.4% in 2027 (from 1.3%). President Lagarde also highlighted the effect of the labour market in supporting the economy, with the unemployment rate sitting near record lows.
In the UK, the BoE lowered rates by 25bps to 3.75%. The decision was clinched on a narrow 5-4 majority by the Monetary Policy Committee, after Governor Bailey switched his vote to support a cut. This was the 6th cut in the current easing cycle dating back to August last year. The statement maintained the guidance that rates were 'likely to continue on a gradual downward path' - though it went on to note in a new inclusion that 'judgements around further policy easing will become a closer call'.
In his policy comments in the meeting minutes, Governor Bailey said there was 'scope' to cut further but there was now 'more limited space' to do so with rates closer to neutral. The overall tone of the meeting saw markets wind back pricing for further easing to around 1-2 rate cuts by May next year. Earlier in the week, 2-3 rate cuts were seen as likely after inflation data in November showed encouraging progress - headline CPI fell from 3.5% to 3.2%yr and core CPI slowed from 3.4% to 3.2%yr - while there were more signs of weakness in the labour market as employment continued to slide (-38k in November).
The Australian government released the mid-year update of its 2026/26 budget. MYEFO reported a slight reduction in forecast cumulative deficits to $143.2bn by 2028/29, down from earlier estimates of around $152bn. The improvement came on the back of significant revenue upgrades, but structural pressures and policy choices mean spending is set to continue rising. The AOFM revised its issuance target to $125bn for the current fiscal year ($62.5bn already complete), down from $150bn previously. My review of MYEFO here has more analysis.
That brings Macro View to a close for the year. Merry Christmas and best wishes.
