It might be the week before Christmas, but 2024 is not done with us quite yet
There’s been plenty to keep us busy this week with a raft of central bank meetings and yet more political news flow. On top of that we’ve had flash PMI data to give us a feel for business sentiment as the year draws to a close.
The US Federal Reserve cut rates as expected, but the hawkish tone in their messaging came as a surprise, and sent US equities significantly lower. The S&P500 index saw its biggest decline on the day of a Fed meeting since 2001 while bond yields and the US dollar moved higher. The 25 basis point cut takes rates to a 4.25-4.5% range but the dot plot of future rate expectations suggested only 50 basis points of cuts next year, down from 100 basis points in the September meeting and less than expected. In the press conference Fed Chair Jay Powell described the rate cut as “a closer call” and said the Fed was “at a point at which it would be appropriate to slow the pace of rate cuts”. Powell said the Fed would need to see “more progress on inflation” to cut further and “were not going to settle” for inflation staying above 2%. Powell said inflation was moving “sideways”, while risks to the labour market had “diminished”. Powell also noted that some Fed officials had taken a “very preliminary step” to incorporate “highly conditional estimates of economic effects of policies [of the new Trump administration] into their forecasts”.
The Bank of England kept rates on hold as expected at 4.75% when they met yesterday with a 6-3 split in the Monetary Policy Committee. The minority called for a 25bps cut while the majority expressed concern that recent increases in wages and prices had “added to the risk of inflation persistence”. The accompanying statement made clear the direction of travel in rates was lower, and a “gradual approach to removing monetary policy restraint remained appropriate”. The Bank downgraded their growth forecast for Q4 to zero from 0.3% previously, saying “most indicators of UK near-term activity have declined”. Governor Bailey said, “we think a gradual approach to future interest rate cuts remains right, but with the heightened uncertainty in the economy, we can’t commit to when or by how much we will cut rates in the coming year.”
It has been another busy week in politics with further developments in both France and South Korea. President Macron nominated François Bayrou as the new Prime Minister of France, the fourth this year. The announcement was made last Friday after further talks. Bayrou is tasked with forming an alliance of the centre, centre left, centre right, greens and communist parties, which would then not be reliant on the support of the far left or far right parties. There is no possible change to the makeup of Parliament before July 2025, so the risks associated with three similar sized and politically opposed blocs remain. The resulting agreement to support Bayrou is not some sort of grand coalition but more of a loose confidence and supply type arrangement with a combined 331 seats and therefore a comfortable majority, albeit made up of parties with very different beliefs and priorities, which means agreement on controversial policies will be difficult. The new government should be in place before year end and will then try to pass a new budget for 2025 early in the new year. Bayrou said the deficit and public debt were a moral and financial problem because “passing it on to one’s children is a terrible thing to do”. However, with only a loose coalition, the ability of Bayrou’s government to make a significant dent in a deficit running at over 6% appears unlikely.
Meanwhile in South Korea, lawmakers voted to impeach President Yoon Suk Yeol over his failed attempt to impose martial law. The decision must now be ratified by constitutional court within 180 days. Yoon vowed to fight on, describing the vote as a “temporary pause” to his presidency. Prime Minister Han Duck-soo has taken over as acting President, saying his focus is to “stabilise the situation” and “bring back normalcy for the people”.
In Germany, the parliament passed a no-confidence vote as expected, paving the way for elections next February. Differences on fiscal policy, and the so-called ‘fiscal brake’ which limits the size of the government deficit, are expected to be at the centre of the campaign. The CDU/CSU party of Friedrich Merz leads in the polls though their willingness to loosen the debt brake remains unclear. Given many other nations are running sizeable deficits, there is pressure within Germany to pursue looser fiscal policies to stimulate the flagging economy. The debt brake was introduced after the global financial crisis and limits government borrowing to 0.35% of GDP. Such a level contrasts hugely with the current budget deficits in the UK, at 4.4%, France at 6.1% and the US at 6.4%. While the UK, France and US deficits are bloated, particularly given relatively benign economic backdrops, there is a consensus in Germany that the debt brake is now too conservative, and loosening this policy could represent a significant economic boost if it is reformed after the election.
In the US, a government shutdown looms after Congress failed to agree a temporary bill to extend government funding. This bipartisan bill would have funded the government to March, by which time Republicans will have full control of congress. However, the bill came under heavy criticism from Tesla CEO Elon Musk and subsequently President-elect Donald Trump jumped on the bandwagon, urging Republicans to reject a “foolish and inept” compromise. A proposal put forward yesterday, which included raising the debt ceiling for two years, was also rejected. An agreement is needed today to avoid a partial government shutdown starting tomorrow, and now that the debt ceiling appears to be part of negotiations, the bar for a deal appears very high. On social media Trump is now calling for the debt ceiling to be suspended until 2029 or abolished altogether. An alarming thought for anyone who thinks some fiscal constraint on US politicians is a good thing….
In terms of the economic data, the flash PMI data for December painted a mixed picture of business sentiment across developed markets. The data for the eurozone was best described as ‘less bad’ than expected though the composite figure remained at a level implying economic contraction. Manufacturing weakness was somewhat offset by services but both France and Germany were at PMI levels implying contraction; hopefully some political certainty can improve the mood in 2025.The UK composite PMI was a little stronger, and in expansion territory while in the US the view is very much ‘glass half full’ on the incoming Trump administration, with the composite figure at the highest level since March 2022 with a very healthy services sector outweighing a manufacturing sector still in mild contraction.
The UK reported both labour market and inflation data this week. Both served to boost market expectations that UK inflation will be ‘sticky’ well into 2025. The employment data showed unemployment unchanged at 4.3%; given the well-known flaws in the current labour market survey, this figure was given scant attention but the wages data, with earnings ex-bonuses moving higher and up 5.2% year on year, dented hopes for multiple rate cuts in 2025. These hopes were further dented by the inflation data, which showed CPI year on year at 2.6% in November and core CPI (which excludes food and energy) at 3.3%. The November CPI figure of 2.6% compared to 2.3% in October, and the direction of travel from here is higher. There are plenty of unknowns for 2025 but where UK interest rates land is an important one for the domestic economy. Just a couple of weeks ago, Andrew Bailey was speaking of his expectation that the UK would see four rate cuts next year totalling 100 basis points, but after the wage and inflation data this week, markets are only pricing just two rate cuts, and the messaging from the Bank of England yesterday on the potential for more cuts was more nuanced. This reflects the expectation that UK inflation will prove to be sticky, with wage growth and services inflation stubbornly high and various tax increases and base effects from energy prices meaning inflation may well be back over 3% by the spring.
It is clear that both the Fed and Bank of England will cut further in 2025 but we are not that far off a time when we reach a neutral rate. The Fed doesn’t need to cut rates much further because the US economy is in robust shape, with summertime concerns over the labour market having dissipated. In the UK the economic momentum is far more sluggish, but of equal concern for the Bank of England is that inflation is too sticky for the Bank to be minded to cut rates much further. Markets will have to get comfortable with a higher neutral level of interest rates than previously anticipated; in the US this is not such a bad thing given the decision is being done as a result of economic strength, but in the UK the environment appears to be more stagflationary.
There won’t be an update next Friday as I fully expect to be either in the pub, on a walk, maybe even a bike ride, or more likely building Lego and playing a game of Monopoly that inevitably ends badly!
Wishing you a very Merry Christmas!
Source: Columbia Threadneedle Investments as at 20 December 2024