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15 Dec 2023

15 Dec 2023

A modest reversal could unfold.

Fading inflation pressures should boost real household incomes in the months ahead, helping support a stronger-than-anticipated rebound in consumer demand within key European markets. Industrial production levels might eke out a modest improvement if Chinese stimulus spending begins flowing in earnest and global inventory cycles normalize. And as rate expectations fall, financial conditions in the euro area are easing almost as quickly as in the United States. We think this could translate into a snapback in credit demand across the economy.  Bloomberg financial conditions indices

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15 Dec 2023

Financial conditions are easing.

With the balance of inflation risks swiftly tilting to the downside, markets expect central banks to begin normalizing policy settings in the coming months. Federal Reserve Chair Jerome Powell’s comments during a mid-December post-decision press conference were widely read as implying a willingness to follow canonical policy guidelines—like the Taylor Rule—in moving even before evidence of a downturn arrives. Further, Fed Board Governor Waller’s late-November comments—in which he explicitly said reducing rates would have “nothing to do with trying to save the economy or recession”—have helped ratify market expectations for a fast and furious cutting cadence. The European Central Bank’s...

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15 Dec 2023

Risk premia are dissipating.

A broad-based stabilization in fiscal governance and cross-Channel relations has lowered economic policy uncertainty levels in the UK over the last year, with both the “moron risk premium” and its Brexit-related equivalent beginning to evaporate in financial markets. In an effort to bolster popular support, Prime Minister Rishi Sunak’s government has pivoted toward cutting taxes and increasing spending – steps that are unlikely to alleviate price pressures, but might help put the economy on a better footing in the long term. And with a general election due to land before January 2025, opinion polls are pointing to a landslide victory...

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15 Dec 2023

Political uncertainty could trigger safe haven flows.

For all their drama, presidential elections typically have very little impact on the economy’s near-term direction, and often leave exchange rates effectively unmoved. But in 2024, the stakes for currency markets will be higher. In early campaigning, Donald Trump – the presumptive Republican nominee – has threatened to apply a “universal baseline” ten-percent tariff on all imports – a step that could inflict damage on the dollar’s major counterparts in a repeat of the dynamics seen after the vote in 2016. We think volatility term structures in foreign exchange markets will develop kinks around November’s polling date as the year...

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15 Dec 2023

The Bank of Japan is playing aggressive catch up.

In our opinion, relative interest rate differentials should continue to shift incrementally in the yen’s favour over the next year. While central banks appear set to maintain restrictive policy settings to ensure inflation is tamed, we doubt further interest rate hikes will be delivered. Indeed, with central banks evolving toward a more data-dependent and risk management-focused approach as growth slows, labour markets loosen, and inflation moderates, expectations about the next easing cycle should intensify. This is likely to see bond yields outside of Japan decline as in past cycles, when rates have fallen once it became clear the monetary tightening...

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