The Last Mile Just Got Harder: Fed Stokes Market Rally + BoE, ECB Previews

That Was Quite the Pivot

Rates tumbling, stocks taking out all-time highs – Jay Powell declared victory over inflation and the market is celebrating the triumph. The question is whether it’s come too soon. You cannot deny inflation is coming down, but it looks as though the ‘last mile’ just got that bit harder. Is it any coincidence that ’24 is an election year? Or is it the tacit acceptance that they won’t hit 2% and need to accept inflation is going to be higher now? Or have they actually done the impossible and won?

Touch paper lit: The Fed lit the touch paper for a monster rally as it greenlit market expectations for rate cuts next year. This was not in the script entirely – whilst we thought the Fed wouldn’t seek to push back against the market entirely, this was a major pivot. The Fed didn’t just say it’s done, it embraced a much more dovish view of the market.

“Declaring victory would be premature,” Powell said. “...But of course the question is 'when will it become appropriate to begin dialling back?" The market didn’t hear the first bit and focused only on the dialling back bit.

The Pivot has Been Swift

On Dec 1st Powell said: “It would be premature to … speculate on when policy might ease.” Yesterday he said: “Rate cuts are something that “begins to come into view” and “clearly is a topic of discussion.” Why so sudden? 6-month annualised core inflation is below the 2.0% target could be a reason – and it seems the Fed is more mindful of being too tight for too long and prefer to act early; maybe learning the lesson of being way too loose in the way into this.

The Fed dot plot showed no more rate hikes and 75bps of cuts for next year, which was a touch more than the x2 25bps cuts I’d thought they would stick with. There was little change to GDP and inflation forecasts, but PCE inflation is still seen above target all the way out the projection horizon. The key was that Powell admitted a discussion on interest rate cuts is coming "into view". Earlier data had shown core PPI was back down to 2% for the first time since January 2021.

Was that the Arthur Burns moment? Powell seems to be ditching his Volcker mask and gone for the Burns one. Janet Yellen has won the argument. The Fed is frontloading rate cuts into the election year – now seeing 3 in ‘24 and 4 in ‘25, vs 2 in ‘24 and 5 in ‘25 in September. The interesting bit seems to be that the Fed has paid attention to the risks of being too tight for too long. “We’re aware of the risk that we would hang on too long,” Powell said, referring to waiting too long to cut rates. “We know that’s a risk and we’re very focused on not making that mistake.” Long-run rates didn’t change – 2.9% for ’26 and 2.5% beyond was the same dot plot as September. They have just brought forward cuts – which is more than enough for the market to read the pivot from Higher For Longer to Cut, Cut, Cut loud and clear.

Yields tumbled to their lowest in some months, the US 10yr below 4% and the 2yr to 4.3%. The 10yr TIPS inflation protection protected yield tumbled to around 1.75% - it had been at 2.5% at the end of Oct. That’s pushed the dollar to a fresh 4-month low with DXY testing 102 now. Cable rallied over one big figure to north of 1.26 and the euro approached 1.09. Gold and oil both rallied as the dollar and yields fell.

Bulls Charge

Stocks surged and we are taking out big levels – the Dow Jones Industrial Average jumped to a record high and closed above 37k for the first time. The S&P 500 rallied 1.4% to cross 4,700 for the first time since Jan 2022.

DAX and CAC hit record highs: Europe has followed suit and the FTSE 100 rallied 2% to 7,700 and break decisively clear of the 200-day line. The CAC added almost 1.5% to clear 7,650, and the DAX rose 1.25% to tap 17,000. Both hit fresh record highs this morning ahead of the ECB meeting later. German 10yr bund yield down from 2.2% to 2.0% this morning indicates the mood…not sure if this helps the ECB much if it’s trying to push back.

As a result of the Fed we maybe need to reconsider just how hawkish or dovish the BoE and ECB need to be today...the move in yields may be something that they are looking at depending on their ex-ante position. Anyway, here is a general overview for today’s meetings.

BoE

Flat GDP growth, declining wage growth and inflation finally coming down – the BoE is all but certain to keep interest rates on hold today. But it will vigilant. The Bank will reiterate that it could tighten monetary policy further and lean against the market’s pricing in rate cuts next year as much as it is. UK interest rate swaps indicate the BoE will be cutting rates by 100bps next year, though Governor Bailey has been cautious about endorsing this view, pointing out that inflation remain too high and dismissing rate cut chatter. Largely, I think the BoE ought to be pushing a higher for longer message more than the Fed or ECB need to do – inflation remains much more of a problem for the UK than either the Eurozone or the US.

On the economic data front, I would be cautious about the thinking the BoE sees much by way to change its thinking from the last time it met. It's watching private sector wages, services inflation and the tightness in the labour market.

Services inflation declined to 6.6%, below the Bank’s forecasts, whilst headline CPI has returned to 4.6% (thanks Rishi). Wage growth has also cooled to 7.3% at the last reading – markets brought forward rate cut expectations afterward. Employment data is a bit more problematic as there are questions about its reliability, but there are definite signs that the jobs market is cooling. The totality of the data backs another pause, but the market is less clear about when the BoE might start to ease next year – if it can afford to at all.

ECB

The ECB will also pause with inflation down to 2.4%, though with markets now expecting ~155bps of cuts in 2024 (vs about 135 before the Fed decision) it will be a hard line for Lagarde to walk. I think the ECB will probably try to embrace the idea of cutting by way of its forecasts, but Lagarde could push back against the market’s pricing for such an aggressive degree of tightening – the last mile message that several Governing Council members have talked about lately will be reiterated. The ECB will want to look at wages before acting – Schnabel last week noted that “We’re going to watch upcoming wage agreements very closely." Inflation may tick up early in 2024 to enable the ECB to wait for longer but the 2025 forecasts should indicate a return to target that ought to guide the market into a landing zone of rate cuts in the second half of the year. I think we can expect the inflation and GDP forecasts both to be lower in 2024 and 2025, which opens the path to cutting. Also watch for a possible tapering of PEPP reinvestments.

FTSE 100 breaks clear of resistance – 7,750 offers next resistance