Investment Institute

Macroeconomics

Fog on the Window

18 March 2024 (10 min read)

KEY POINTS

We explore the risk the Fed cannot cut at all this year. We are not convinced.

We look at the potential ramifications for the ECB of the Fed postponing its first cut beyond June.

The outcome of the wage negotiations opens the door wide to the BOJ normalisation.

The market has moved markedly from its exuberant expectations of massive cuts by the Fed to price barely three cuts in 2024. The mood music is that there is now a distinct risk the US central bank will be unable to cut at all this year because of a window for easing closing well ahead of the presidential elections. We agree that some key details in the latest prints of the consumer price index are concerning but we also think there are enough signals elsewhere for Jay Powell to continue to guide towards a gradual removal of some of the current restrictive stance. The revised data for January and the February print for wages have been reassuring, with a pace consistent with a return to 2% inflation given the US strong productivity performance. We also highlight a very recent paper by the Brookings suggesting that the much higher than expected net immigration in the US could explain why the US economy could continue to create many jobs without triggering further tension on wage. On the political constraints, we think it would be reputationally very dangerous for the Fed to allow the looming elections to influence its reaction function and choose inaction if the data warranted a monetary easing, and there is no obvious historical pattern to substantiate a strong influence of the pre-electoral context on Fed decisions.

We explore the consequences for the ECB of the risk the Fed would not cut in June. The only strong argument in favour of taking on board the Fed’s attitude would be the potential impact on European inflation transiting through another depreciation in the exchange rate. Yet, we think that the current euro exchange rate level already takes on board a baseline in which the ECB cuts more than the Fed this year, and in any case the ECB’s key focus now is domestic inflation, not the role of external forces.

There is quite some trepidation on the possibility the Bank of Japan could end its negative rate policy this week already. The results of the wage negotiations certainly fuel the BOJ’s resolve to start normalising, but we still think moving in April presents some advantages. What really matters anyway is not whether the BOJ moves in March or April, but how it will handle the end of Yield Curve Control.

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