Powell Ponders Pivot

For the week ending 15 December 2023

As of midday Friday, global equities were sharply higher on the week, with several indices, including the Dow Jones Industrial Average, closing in record territory in recent days. The yield on the US 10-year Treasury note plunged from 4.22% last Friday to as low as 3.89% after the US Federal Reserve signaled it has begun to contemplate rate cuts in 2024. The price of a barrel of West Texas Intermediate crude oil rose a dollar to $71.70 while volatility, as measured by the Cboe Volatility Index (VIX), inched down to 12.2 from 12.8. 

MACRO NEWS

Surprisingly dovish Fed spurs asset rally

Fed Chair Jerome Powell’s remarks following Wednesday’s conclusion of the meeting of the Federal Open Market Committee — coming just two weeks after he sought to dampen expectations of a dovish pivot — opened the monetary floodgates. Markets priced in as many as seven rate cuts by the end of January 2025, up from five ahead of the meeting, with traders betting the first move could come in March. The combination of favorable Consumer Price Index and Producer Price Index data this week helped set the stage for the FOMC to begin discussing the timing of rate cuts at the meeting, which surprised the market. Powell said the committee was mindful of the risks of holding rates too high for too long. To avoid an inflation overshoot to the downside, Powell said the Fed would cut rates well before it reached its 2% target. FOMC members penciled in three rate cuts in 2024, up from two in  their September forecasts. Stocks, bonds and commodities all rallied on the unexpectedly dovish commentary. 

NY Fed’s Williams pushes back against pivot

On Friday morning, Federal Reserve Bank of New York President John Williams, one of the most influential FOMC members, sought to tamp down market enthusiasm over the prospect of rate cuts. “We aren’t really talking about rate cuts right now,” he told CNBC, adding that we need to be ready to tighten policy further. Williams said it is premature to be thinking about rate cuts as early as March and the question now is whether policy is sufficiently restrictive. Markets are reacting more strongly than they should based on the data, he said. 10-year yields rose modestly after the comments but remain below 4%.

ECB, BOE much less dovish than Fed

The European Central Bank and the Bank of England met on Thursday, the day after the Fed did, but they were much more cautious in their commentary after each held rates steady. The ECB announced it will reduce its reinvestment of maturing principal payments within its Pandemic Emergency Purchase Program in the second half of 2024, which will have the effect of tightening monetary policy. In contrast to the Fed, ECB President Christine Lagarde said the Monetary Policy Committee did not discuss rate cut. Earlier Thursday, the BOE forcefully pushed back against the notion of an early dovish pivot as three of the nine members of the MPC voted to hike rates. BOE Governor Andrew Bailey said that while he is encouraged by the improved outlook on inflation, he is concerned by its persistence. After the central bank meetings, the euro and pound both rallied strongly versus the dollar in anticipation of narrower interest rate differentials.

Japan’s PM reshuffles cabinet amid scandal 

Japanese Prime Minister Fumio Kishida replaced four cabinet ministers on Thursday amid a deepening scandal involving lawmakers concealing income raised at fundraising events. Prosecutors are expected to raid the homes and offices of some Liberal Democratic Party members caught up in probe, local media reported this week. Kishida’s popularity continues to decline, polling shows, with his support slumping to just 17.1% according to a survey published Thursday. 

Mixed data from China 

China’s economy put in a mixed performance in November, with industrial production rising 6.6% year over year, beating estimates. Retail sales, however, rose 10.1% over the same period, falling substantially short of expectations. Residential property sales fell 4.3% compared with a year ago while new home prices slumped for the sixth straight month, falling 0.37% in November. 

QUICK HITS

Argentine President Javier Milei was sworn in this week and immediately signed an executive order reducing the number of government departments from 21 to 9 to reduce bureaucracy and overhead. His government also quickly devalued the peso by 54%, taking it closer to the underground market rate, and cut transfers to provinces, suspended public works and lowered subsidies. The spending cuts announced this week total about 2.9% of GDP. 

More than 190 governments at the United Nations Climate Change Conference in Dubai agreed to “transition away” from fossil fuels. However, the language of the deal contains more caveats than earlier drafts, which called for “a phaseout.” 

European Union negotiators last Friday clinched a deal on the world’s first comprehensive set of artificial intelligence rules, paving the way for legal oversight of AI technology. 

US November CPI rose 0.1%, while the ex food and energy measure rose 0.3%. Year over year, prices rose 3.1% while core prices held steady at 4%.

US November industrial production rose 0.2%, slightly below forecasts. 

US Secretary of the Treasury Janet Yellen said this week that the United States is on the path to a soft landing and that rising real rates may impact Fed decisions on the rate path. Inflation is “certainly meaningfully coming down, and I see no reason, on the path that we’re currently on, why inflation shouldn’t gradually decline to levels that are consistent with the Fed’s mandate and targets,” she said.

The British economy contracted 0.3% in October and was flat from the prior quarter’s level. Industrial production declined 0.8% in October. 

Analysts said that China’s Central Economic Work Conference stopped well short of signaling it will undertake stimulus boost consumption. While policymakers recognized that China’s economic recovery is “at a critical stage,” the CEWC statement did not imply there would be aggressive fiscal stimulus or monetary easing. Nor was any plan to stabilize China’s property market announced. 

Norway’s Norges Bank delivered a hawkish surprise on Thursday, raising rates 0.25% to 4.5%. 

The US House of Representative voted this week along party lines to authorize an impeachment inquiry against President Joe Biden, formalizing an informal inquiry that has been underway for some months.