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US and Europe on divergent rate cut paths

market snapshot

12 April 2024 |
Active ESGMacro
Rising inflation in the US and cooling prices in the eurozone increasing likelihood that the ECB will cut rates before the US Federal Reserve.

Fast reading

  • US inflation posted a higher-than-expected 3.5% annual increase in March bolstering expectations that the Fed may have to delay policy easing.
  • The Fed’s ‘dot plot’ of individual interest rate projections suggests FOMC members now expect to cut rates just twice this year.
  • In Europe, a June cut remains on the cards after inflation fell to 2.4% in March. The ECB held its benchmark rate at 4% this week, but signalled it could cut at its next meeting.

A jump in US inflation in the first quarter has prompted a shift in market sentiment and has led investors to scale back rate cut expectations.

The US consumer price index posted a 3.5% annual increase in March, after a 3.2% gain a month earlier. The higher-than-expected inflation figures – following a fall to 3.1% in January – suggests that rising prices remain difficult to control and that US Federal Reserve may have to delay easing.

The latest data – released on Wednesday – means any possibility of a June rate cut by the Fed is off the table, says Geir Lode, Head of Global Equities at Federated Hermes Limited. “Forecasts for rate cuts in 2024 have been slashed from six to two,” he says.

Figure 1: Implied Fed funds target rate – 2024 forecasts scaled back

Source: Bloomberg as at 11 April 2024. The Fed offers forward guidance with its dot plot every quarter. Each dot represents a member of the Federal Open Market Committee (FOMC) and their view on where interest rates should be.

The Fed’s ‘dot plot’ of individual interest rate projections suggests Federal Open Market Committee (FOMC) members now expect to cut rates twice this year, as policymakers aim to achieve a 2% inflation target. 

“If higher inflation data persists, we estimate that the likelihood of a rate hike this year will surge to 10-15%,” Lode adds.

“However, corporate earnings remain robust, with earnings estimate cuts way below typical levels at the end of the first quarter. Buoyed by a strong economy and the prospect of two rate cuts, we maintain a bullish outlook on the stock market.”

ECB considering cut

In Europe, however, a summer rate cut remains on the cards, after eurozone inflation fell to 2.4% in March, lower than forecast.

The European Central Bank (ECB) held its benchmark deposit rate at 4% at its meeting in Frankfurt this week, but signalled it was considering a cut at its next meeting in June.

“The ECB may cut rates in June even if the Fed holds off,” says Linda Duessel, Senior Equity Strategist at Federated Hermes.

The ECB may cut rates in June even if the Fed holds off

The cooler inflation outlook in Europe, which may allow the ECB to start cutting interest rates sooner than the Fed, could support a shift away from US Treasuries towards European government bonds. In the US, the yield on the 10-year US Treasury had risen 17% YTD to 4.5% on Thursday at 16:00 GMT compared to the 10% YTD rise to 2.4% in the yield of the equivalent German Bund1.

Figure 2: 10-year US Treasury yield on the rise

In stock markets, the pan-European Euro Stoxx 50 is up 9.8% YTD; the US blue-chip S&P 500 is up 8.1% YTD in comparison2.

There have been indications of an upturn in global manufacturing, says Duessel. “The global manufacturing PMI has risen to 50.6 and Chinese manufacturing has surprised to the upside,” she says. “Emerging market central banks are already cutting rates, even as the BRICs are seeing manufacturing growth and new orders above 50 in the latest manufacturing PMI,” she adds.

Sweden’s manufacturing Purchasing Managers’ Index (PMI) is now at 50 after 19 months of contraction and the manufacturing PMI in Greece rose to 56.9, its highest level since February 2022.

For further insights on fixed income please see: SDG Engagement High Yield Credit 2023 Annual Report

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