La Française: Expectations of rate cuts have been postponed

14 februari 2024

By François Rimeu, Senior Strategist, La Française AM

Confirmed rate cuts... But postponed

Early expectations of rate cuts by central banks were delayed due to exceptionally positive economic data in the US and less accommodative statements than anticipated from central bankers during the January monetary policy meetings. Nonetheless, they confirmed the possibility of rate cuts later this year, as inflation is expected to slow towards the 2% target for 2025. The lingering question now is: when? Central banks are awaiting more confidence that inflation is indeed trending downward before initiating any monetary policy easing.

On the macroeconomic front, US GDP for the fourth quarter surged by an annualized 3.3% quarter-on-quarter, once again surpassing expectations. Additionally, the International Monetary Fund (IMF) has upwardly revised its growth forecast for the US this year from 1.5% to 2.1%. Similarly, the OECD has done the same.

In January, the US economy added over 350,000 jobs, compared to an average of 255,000 per month in 2023. Wage growth accelerated to 4.5%, likely influenced by the decrease in hours worked. US consumers also appear to be regaining optimism. As anticipated, there was also a rebound in manufacturing activity in January, which is expected to persist.

As for the European activity, the economy has been globally stagnant since the end of 2022. The eurozone narrowly avoided a technical recession in the fourth quarter of 2023, with stable GDP growth, but with opposite trends between countries.

Spain and Portugal showed resilient growth of +0.6% and +0.8% respectively, and Italy +0.2%, while activity in France remained sluggish and Germany showed a negative growth of -0.3%. However, the business sentiment surveys for January (PMI, ZEW) and the ECB's quarterly household and business credit survey for Q3 2023 and Q1 2024 indicated signs of a slight rebound ahead.

In 2023, China's growth reached +5.2% compared to +3.0% in 2022, aligning with the 5% target set by authorities. However, the Chinese government is confronted with several challenges, leading to the implementation of multiple monetary and fiscal support measures to bolster the economy, including the earlier and more pronounced than expected reduction in the reserve requirement ratio on January 24th.

Additionally, according to Bloomberg, the Chinese government may raise 2 trillion yuan ($260 billion) from state-owned enterprises to bolster Chinese equities. The GDP deflator remained negative for the third consecutive quarter (-1.5% year-on-year), indicating subdued inflationary pressures and a slowdown in domestic demand amidst significant challenges in the real estate sector and elevated local government debt levels. This subdued inflationary pressure is helping to mitigate the risk of an acceleration in price levels in Europe.

A more contrasting scenario in China and geopolitical uncertainties in the Red Sea

The situation in the Red Sea remains complicated and seems unlikely to be resolved in the immediate future. As highlighted by Christine Lagarde during her latest press conference, sea freight costs only represent 1.6% of the average production costs in Europe, thereby reducing the possibility of a new inflationary crisis.

However, it remains very difficult to have certainties with such an unstable situation, due to Houthi rebels attacking submarine cables while 30% of world trade in goods will have to be reorganised. Can investors fear a new supply shock against the backdrop of an overall improvement in the economy, and revise upward the risk of inflation? In our view, this scenario is more likely to happen in the United States than in Europe.

Meanwhile, there's renewed attention on banks, with two financial institutions currently facing distress. New York Community Bancorp's stock is plummeting after unexpectedly announcing a loss in the fourth quarter, attributed to higher provisions related to its commercial real estate (CRE) portfolio.

In Europe, Deutsche Pfandbriefbank is likely the most discussed stock in the credit market, once again due to its exposure to US commercial real estate. While the issues confronting these two banks appear specific (Signature buyout for the former and very high exposure to US CRE for the latter), confidence is paramount in the banking realm and can erode rapidly. Nevertheless, authorities are expected to respond promptly should a crisis of confidence emerge.

In January, bond markets experienced a slight decline, while equity markets showed relative resilience. Except for Chinese equities, risky assets performed better, showcasing significant sectoral disparities, with technology stocks maintaining dominance.

In the near term, there's a potential for further correction in bond markets as economic activity rebounds, possibly impacting risky assets. However, in the longer term, the economy's resilience and the anticipated rebound in manufacturing activity are good news for equity indices, especially for medium-sized US firms.

February/March outlook

Expectations for global economic growth to continue improving in the weeks ahead. There's a possibility of inflation ticking up due to rising prices in PMI surveys. This might lead central banks, especially the Fed, to keep up their tough stance on policy communication to delay any potential interest rate cuts.