ECB Leads the Way as the Fed Contemplates it's Next Move.




By Chinedu Okoye 



Summary:

- The Fed should remain cautious and data-dependent, and future rate cuts should depend on inflation, unemployment, and consumer spending data.

- Despite expectations, the ECB cut rates first on June 6th. Europe's growth forecast of 0.8%, declining inflation, and geopolitical uncertainties make a stronger case for easing by the ECB.

- A late Fed rate cut poses fewer risks and could benefit emerging markets, creating investment opportunities.

- Both the Fed and ECB are expected to reduce rates more gradually than their rapid tightening, necessitating preparation for prolonged higher rates and currency market fluctuations.



Sticky US Inflation: 

Inflation in the US started the year on an upward trajectory, growing from 3.1% in January to 3.5% in March, delaying the anticipated cut in the Fed funds rate. The Federal Reserve remains data-dependent and has hesitated to cut, with no clear signal of cooling prices or consumer spending. 

Other economic indicators have also come in with less-than-satisfactory numbers. The PCE has steadied at 2.7% and 2.8% for Core and Non-Core PCE, respectively, and the Employment Cost Index (for wages/salaries ex. benefits and other worker entitlemens), a quarterly figure, came in at 4.2% in Q1. Unemployment steadied at 3.7% from January through April and jumped to 4.0% in May's reading.



The Fed's Next Move on Rates: 

The answer to when the Fed would cut, by how much, and how many times in the year would depend on further readings, not just inflation, but also unemployment and consumer spending. Zero Equilibrium earlier expected that the US Federal Reserve would lead the monetary easing, as they did with the tightening, however, the ECB beat them to it and cut on Thursday, June 6th. 

Even though Jerome Powell has made remarks on when and how many times we might expect to see a cut this year, it isn't set in stone. Therefore, until we see subsequent price level drops, a cooler consumer spending, the Fed Funds rate may remain at 5.50%. 

A consistent drop in PCE would be indicative of a slowing economy and demand reacting to high costs of borrowing; jobs numbers dropping further or staying out may also give the Fed a signal to ease. That way, when rates go low, consumers aren't in a rush to go on a spending spree fueled by cheap credit, even as businesses get a breather from high borrowing costs.



ECB Leading the Easing: 

For the Fed, a late cut carries lesser consequences compared to an early cut. Whatever arguments could be made for a Fed cut, it is undeniable that Europe needs it more. Growth for the region is estimated to be 0.8%, inflation has declined consistently from 5.3% in January to 2.4% in April, suggestive of a shift towards a more cautious spending environment by businesses and consumers. 

Add to that the uncertainty around the Russia-Ukraine conflict and exposure to energy prices; the Eurozone monetary authority has a strong impetus for a cut. However, Europe may want to avoid overplaying its hand and watch out for exchange rate repercussions and be as much data-dependent on easing as they were on the tightening. The policy should only be as accommodating as internal and external economic conditions allow.



Final Remarks: 

Overall, the prospects of a Fed hike are welcome news to emerging markets and could create opportunities for investors to lock in attractive yields. We could also see longer-duration plays in advanced country bonds. 

However, in the event that the above data sets surprise in the future, the Federal Reserve might deliver the cuts later than planned. In any case, we expect the Fed and ECB won't cut as fast or as frequently as they initially raised benchmark rates. 

Investors and individual market participants will want to plan for higher-for-longer rates and fluctuations in the currency markets from these rates decisions or lack of.

Comments

Post a Comment

Popular posts from this blog

US China Trade War, Winners and Losers, and Implications for the Global Economy

Image
- By Chinedu Okoye    Summary: Winners and losers in this conflict can't be measured in monetary terms as both sides lose in that regard. The real differentiation lies in long-term economic positioning. The Trump administration seems to miss the transition of the US economy, and this moves could actually stall and take way the focus from long-term sustainability to short-term (political) gains. Ironically the US needs these deficits to maintain the balance of payments surplus it runs from gigantic inflows it receives from foreign investors into private and government securities. The trade war and threats to "isolate China" has sever implications for US position and influence in the global economy as it is basically strongarming allies, and giving China more leverage.   Introductory Remarks: Trump is going aggressive as China is gently forging ties, whilst issuing stern warnings of US collusion. Bot...
Read more

Zero Equilibrium Revised 12 Month Naira Outlook:

Image
By Chinedu Okoye  Spot Rates Strengthens Beyond ZE Expectations: Spot USD/NGN is currently N1,490.33, reflecting continued relative strength of the Naira against the USD and other majors.  At the time of our last  ZE Naira outlook : The Naira was selling for N1560/$1. And at the N1500/$1 - N1600/$1 range, was as “relatively strong”. This just inside the strong case zone in the earlier ZE Outlook where it was state that; below N1500 - N1400/$1 as a strong case scenario; N1500-N1600/$1 as the baseline level, and; above N1700+/$ as the most bearish scenario. Given the economic developments on the global economy (a range of monetary policy decisions and forward guidance, changes in the Oil market, and CBN monetary policy) since our last Naira outlook earlier in the year, for FY 2025. Going NGN/USD 12 Month Forward Rates: Data from @Investingcom showed Forward points from Investing.com translate into 1-year forwards at N1,703 (bid) and N1,783 (ask), implying a +...
Read more

Government Spending, Debt and Growth.

Image
- By Chinedu Okoye  Synopsis: Fiscal authorities act as a stabilizing mechanism in the goods and services market in periods of high uncertainty and slow or even negative output growth. However a level of efficiency is required if the expansion is to yield the intended benefits. Tis is because, indiscriminate deficit spending with no distinct purpose could be hyperinflationary. A prioritized budgetary allocations according to value added on a cost-benefit basis should be the none of any effective fiscal expansion. Not doing so could lead to erratic spend and income redistribution that creates economic imbalances and Stokes inflationary pressures, rather than provide economic stability. Fiscal expansion must be more about stabilizing and supporting the markets, with job creation as an inevitable consequence, such that the jobs created as a result add value to society. The effects of a crowding-out of private investment is more likely to occur when deficit spending c...
Read more