A Fed that surprised with a dovish turn by opening the door to rate cuts has added weight to the year-end rally in equities and fixed income, reducing a host of other top-tier events through the week to little more than glancing interest for markets. Equities advanced broadly (but underperformed in Europe and China), the USD came under renewed pressure and bond yields fell sharply. At this stage, the Fed stands in contrast to the pushback seen at the ECB and BoE to expectations for rate cuts despite presiding over much weaker economies.
Although the Fed's FOMC held rates in the 5.25-5.5% range this week, the Committee is now openly discussing rate cuts - something Chair Jerome Powell had said would be premature only a couple of weeks ago. Markets were emboldened by this shift in messaging, bringing forward their timing for the first cut to March (from May) and pricing in more cuts next year (150bps from 125bps).
In the post-meeting press conference, Chair Powell explained that with the Committee seeing what it had been wanting to see in the US economy: strong growth moderating, heat coming out of the labour market and inflation cooling, discussions were turning towards 'when it will become appropriate to begin dialing back the amount of policy restraint that's in place'. That framing is crucial and contrasts with a situation where the Fed is easing to head off a recession. Data this week showed retail sales outperformed expectations with a 0.3%m/m rise in November; meanwhile, headline inflation printed at 3.1%yr in November (from 3.2%) and the core rate was unchanged at 4%yr, both as expected. Notably, Chair Powell also said that rates could be cut before inflation was back at the 2% target to avoid leaving restrictive policy in place for too long.
This discussion of policy easing was predicated on the FOMC's updated dot plot increasing the number of rate cuts implied for 2024 from 2 to 3, while it also needs to be remembered that the rate hike it had signalled for this meeting back in September has not eventuated. Broadly, the accumulation of FOMC members' forecasts points to an expected soft landing for the US economy in 2024, with growth cooling to 1.4% (revised from 1.5%) but unemployment rising only modestly from 3.8% to 4.1% (unchanged). These dynamics see the projections lowered for both headline (2.4% from 2.5%) and core inflation (2.4% from 2.6%) to be within reach of the 2% target by year-end in 2024.
Source: Kathy Jones (Charles Schwab) via Twitter/X
By contrast to the Fed, policymakers at both the European Central Bank and the Bank of England continued to push back on prospects for rate cuts at their respective meetings this week. At the ECB, the Governing Council held its key rates unchanged (MRO 4.5%, MLF 4.75%, DF 4%) while reaffirming the need for these settings to be left in place "for a sufficiently long duration". It was also announced that reinvestments of maturing bonds in the PEPP portfolio would be tapered through the second half of 2024, reducing at a run-rate of €7.5bn per month and discontinued by year-end.
While markets price around 150bps of cuts next year, ECB President Christine Lagarde held firm in the post-meeting press conference saying it would not lower its guard. This came as the ECB's updated macroeconomic projections marked down an already weak growth outlook to 0.6% in 2023 (from 0.7%) and 0.8% in 2024 (from 1%) and sharply lowered its 2024 headline inflation forecast to 2.7% (from 3.2%), with the core rate also easing to 2.7% (from 2.9%). But inflation is still seen on a protracted path back to the 2% target in 2025/26 and President Lagarde said risks remained around domestic price and wage pressures.
The BoE's Monetary Policy Committee (MPC) held a steady hand at 5.25% on Bank Rate. A 6-3 vote (the minority with siding with a 25bps hike) and a continuation of the line that restrictive policy would likely be required "for an extended period of time" gave the decision a clearly hawkish tilt. The meeting minutes conveyed that the core of the MPC remains alert to inflationary risks due to ongoing pressures in services prices and wages. There remains an expectation that these pressures will be slow to ease.
In Australia, both the November Labour Force Survey and the mid-year update to the 2023/24 Federal Budget were neutral from an RBA perspective. Employment is accelerating into year-end rising by 61.5k in November, surprising strongly to the upside for the second month running following a 42.7k gain in October (full review here). Surging population growth is supporting employment and adding to labour supply, the participation rate resetting to a new record high (67.2%). This is rebalancing the labour market, resulting in the unemployment rate rising to 3.9%, still very low historically but now up 0.5ppt from cycle lows a year ago. Hours worked (0%m/m) showed further signs of being a margin of adjustment to slowing economic growth.
Significant upgrades to forecast revenue on the back of economic resilience, surging population growth and elevated commodity prices is estimated to deliver a windfall of around $67bn to the government over the next 4 years. In MYEFO (reviewed here), the Treasurer indicated 92% of the windfall would be used to offset future pressures on spending, lowering forecast deficits. New policy announcements add a modest $5.3bn of new stimulus through to 2026/27. In response, the AOFM announced its funding task for 2023/24 was expected to be $50bn (of which $23.6bn has already been completed), down from $75bn anticipated following the May Budget.
