AXA IM: Significant gap between Fed-forecast and market expectation

December 11, 2023

No hard announcement expected from Fed and ECB, but it will be hard for them to ignore dramatic shift in monetary policy trajectory expected by the market.

‘We think there is a strong case for the Fed to try to steer the market away from its most extreme pricing since broad financial conditions are on the brink of standing in the way of what the central bank has been trying to achieve,’ said AXA IM today. ‘The Fed has one handy tool at hand to signal a disagreement with the market. Of course, the ‘extra hike’ in the previous dot plot failed to materialize (barring the mother of all policy surprise this week) which will further undermine the credibility of these rates forecasts, but it remains a nice messaging device. The September version had the Fed-Funds in the 5-5.25% range at the end of 2024, implying only a 50-bps cut from the peak forecasted at the time.

The Fed could maintain a ‘high for long’ message by keeping the same change in the policy rate from the actual end-2023 level, hence bringing it down to the 4.75%-5.0% at the end of 2024. Since it is a collection of individual forecasts, precise steering is not always possible, but the crux of the matter is that there would still be a significant gap between the Fed’s forecast and the market’s expected trajectory.’

ECB should stay on steady course

The ECB is expected to remove further hikes from the debate, but also to call for prudence in the face of impatient markets, and stress that the next months’ inflation readings may be less spectacular. ‘Headline inflation is unlikely to decline much more in year-on-year terms in the next few months ahead, as most of the powerful favourable base effects are now fading. Still we expect some small downward revision to the inflation forecasts for 2025 to 2.0%, from 2.1%, which would be consistent with a central bank increasingly confident it has done enough, but still far enough into the projection horizon to call the market for prudence in its pricing of cuts.

Our baseline for the first cut remains June 2024, but the speed of disinflation – occurring faster than we expected – makes it plausible a cut intervenes earlier in Q2. Our point though is that we fail to see why the ECB would want to engage in this discussion right now. We think it is better off maintaining a steady course.’