Carmignac: Peak pessimism and peak optimism in december central bank meetings

December 12, 2024

Kevin Thozet, member of the investment committee of Carmignac, looks ahead to the different december central bank meetings and sees peak pessimism and peak optimism:

The European Central Bank (ECB) - 12 December
'Markets expect a 25 basis points cut this week, and subsequently, until policy rates land at 1.75% in the summer. The question for investors is whether a jumbo 50 basis point cut is on the cards over the period.
In our view, concerns around slowing growth due to Trump’s tariffs and political uncertainty across the region mean the landing rate could be lower than the market expects (1.5% or less). However, we still believe a 50 basis point cut is unlikely for now given the upside surprise on growth over Q3, the hawkish repricing of the Fed cycle since the last ECB meeting and that it is too early to factor the uncertainty around the adverse effects of Trump’s policies.
On the much watched ‘language front’, we think the ECB could signal its intention to move from a “meeting by meeting approach” towards a “willingness to get to neutral rates” to integrate the risk associated with weak consumer sentiment and political uncertainties. By doing so, it could reinstate some form of dovish forward guidance.
Finally, this month will also see the end of the reinvestments of the proceeds of bonds held under its purchase programs (both for the Asset Purchase Programme and the Pandemic Emergency Purchase Programme), hence from 1 January, the ECB balance sheet will run off by €40 billion per month. The disappearance of a price insensitive buyer 10 years after the start of the APP does also call for some form of wariness on the euro rates market.
Indeed, 2025 is poised to be another record year of government bond supply, with €600 billion of net issuances expected and deficit trajectories of countries such as France not being as benign as initially expected. This is unlikely to appeal to investors, especially as better yielding opportunities can be found elsewhere and that the credit rating of major issuers such as France could be downgraded.

The Federal Reserve (Fed) – 18 December
Contrary to the ECB, inflation data is in the driving seat for the Fed, as the growth environment is reasonably strong. Markets are expecting a less than 25 basis point cut at the December meeting and barely three cuts over the coming six months.
We expect the Fed to proceed with its second 25 basis point cut in a row next week, but to halt its cutting cycle over the first quarter of 2025 on a 4% plateau.
Over the short term, the Fed is unlikely to ‘guesstimate’ what Trump’s policies will become in January. So for now, it’s likely to remain on the path it’s signalled since it started lowering policy rates last September.
However, over the medium term (one quarter), should government policy push growth, prices, and the deficit higher while the output gap is largely closed, the Fed could take a hawkish turn.
Over the short term, the US yield curve will likely steepen, with markets not fully reflecting the expected interest rates cuts, nor the lingering inflationary pressure. Currently, a somewhat benign inflation scenario is being reflected in longer-term fixed income instruments.

Swiss National Bank (SNB) – 12 December
Markets expect the SNB to cut by 50 basis points and to bring policy rates to 0% within the next six months. With inflation printing below target (headline inflation at 0.7% and core inflation at 0.9%), modest economic growth and a strong currency, the SNB is expected to seek to outpace the ECB in its cutting cycle to hinder the upward trajectory of the Swiss Franc. But with the Swiss Franc having a much greater beta to gold than to interest rate differentials, the effectiveness of this strategy remains to be seen.

The Bank of England (BoE) – 19 December
While markets are expecting as few interest rate cuts for the BoE as the Fed, the economic outlook is somewhat different between the two parts of the ‘special relationship’. Hawkish expectations for the BoE have led to a historical gap between euro rates and sterling rates – they are now as wide as during the Liz Truss mini budget drama. While the sizeable UK deficit will require financing with high real rates, the UK economy is still linked to that of the old continent (40% of UK goods and services i.e. £350 bn are exported from the UK to the EU accounting for 13% of GDP). As such, the BoE will likely follow the footsteps of the ECB, not the Fed, in its rate-cutting cycle, especially if the hopes resting on consumer spending to support economic growth prove short-lived.

Asset allocation impact
To conclude, we remain largely cautious on developed market rates markets.

With expectations for ECB cuts potentially going too far, and markets quick to price further US exceptionalism, on short-term maturities we prefer US rates to euro rates.

We are largely staying shy of the developed market sovereign bond space which, despite circumstances, offer a meagre 4% (in USD terms) to 2% (in EUR terms) yield for core countries – and not much more for so-called ‘peripheral’ or ‘semi-core’ (for now) countries.

Finally, the flat yield curve, and the lingering inflation question, leads us to prefer bonds linked to real rates (i.e. inflation-linked) over nominal ones.'