Currently the gap between perception by financial markets and public opinion could not be wider. Take Germany for example, last week German media had strong financial headlines; Germany no longer matters on a global scale (though we are still talking about the fourth-largest economy worldwide and the largest one in Europe, according to the International Monetary Fund), German stock-listed companies left the country (in reality, Germany is still the third-largest exporter worldwide) and so on. Before you call this a specifically German issue, US consumer confidence is also hovering around the depression lows of 2008/2009, while US consumer spending hit another all-time high this year.
US pushing against early rate cuts
While US consumer confidence continues to see lows, the US economy remains firmly on track for a ‘soft landing’. The latest US labour market report surprised with more job gains than expected. At the same time, we still see some softening when it comes to US growth dynamics.
However, the good news is that the cooling of the labour markets is not causing as much economic pain as feared. The upcoming inflation report, which is set to reveal some volatility in the easing of inflation, fully supports a data-dependent Fed that will push against expectations of early and material rate hikes in 2024. We see a decent chance that the Fed will refrain from declaring victory when it comes to its fight against inflation. At the same time, the previous tightening bias, which until recently left the door open to additional rate hikes, will most likely be dropped or soften markedly. Given that money markets discount the first rate cut in May 2024, the Fed will most likely see some need to push against this rate-cutting expectation by labelling it as premature.
Central banks in Europe: The ECB looks to be the early cutter
Besides the US Fed, this week features the ‘full monty’ of large central banks in Europe. The European Central Bank (ECB) is increasingly confronted with calls for rate cuts given that deteriorating economic momentum shows the eurozone economy has more problems digesting higher rates than the US. The downward surprise in November inflation brought forward the market pricing of the first ECB rate cut to March 2024, with a total of 125 basis points of cuts priced in for 2024. We agree that the ECB has more reasons to start discussing rate cuts this Thursday. Nevertheless, market pricing seems a tick too aggressive, in our view. We expect the kick-off of cuts in April.
After low inflation enabled the Swiss National Bank to hold since June, many expect it to start cutting rates simultaneously with the ECB. We doubt this notion, which is based purely on lower Swiss inflation and ECB cuts, due to the large share of administered prices in Switzerland. This renders inflation less volatile than in peer economies but will likely bring delayed upside pressure from expected rises in energy bills and hikes in public transportation fares at the start of next year. We therefore expect the SNB to be firmly on hold this Thursday and remain so throughout 2024.
Given that core inflation in the UK is stickier than elsewhere and is expected to recede slower than in peer economies, the Bank of England (BoE) also has reasons to be patient with cutting rates. Nevertheless, the economic stagnation in the past, current, and coming quarter suggests serious fragility to the currently tight rates. Therefore, we expect the BoE to cut rates twice next year, starting in September, which is close to the markets’ pricing in of a kick-off in August.
COP 28: The travelling circus does its circles
The climate summit in Dubai is in its final phase and could also be an example in perception vs facts. While most participating countries would like a statement to mention the phasing-out of fossil fuels, the petro nations, especially Saudi Arabia, remain in strong opposition.
As expected, there are no meaningful and tangible outcomes that investors need to be aware off. Among the positives are the direct talks between the US and China, which could help improve their strained relationship overall. The focus again was largely on energy and fossil fuels, while food systems remained overlooked. The reality is that the solutions required to reach net zero largely already exist today. The hurdles to their application are very often simply rigid consumer habits and market structures.
What does this mean for investors?
In the long run, it is another call for ‘factfulness’, as the late Hans Rosling put it. If anything, history tells us that financial markets have been a better gauge for economic prospects than public discourse. In the short run, it means ignoring the abundant negativity and tracking the actual data. Therefore, we only make moderate changes in ratings before the holiday season.