Markets dial back on deep ECB rate cuts this year

Refrain from central bank officials strike a more cautious tone about the outlook for easing

Wed, 17 Jan, 2024 - 19:08

Traders in the world’s largest bond markets are heeding warnings from central banks and winding back bets on aggressive interest-rate cuts this year.

European Central Bank (ECB) president Christine Lagarde added fuel to the selloff, saying in an interview at the World Economic Forum in Davos that market bets on a big easing of policy are a distraction.

Ms Lagarde said while the central bank is likely to cut interest rates in the summer, market expectations of more aggressive easing could be counterproductive.

“It is not helping our fight against inflation, if the anticipation is such that they are way too high compared with what’s likely to happen,” she said.

Money markets responded by paring the extent of cuts expected from the ECB this year.

They now see 137 basis points by year end — equivalent to five quarter-point moves, with a 50% chance of a sixth.

There is also less conviction that the first move will come as soon as April, seen as a certainty until now.

The comments are part of steady refrain from central bank officials striking a more cautious tone about the outlook for monetary policy easing.

The latest rounds of data lent more credence to the warnings, highlighting the risk that premature policy pivots could sow the seeds of an inflation resurgence.

Investors once virtually certain that the US would kick off an easing cycle in March now see the odds as no better than a coin toss —
as a bigger-than-expected jump in US retail sales underscored the US economy’s strength.

A similar repricing is under way in Britain, where bond yields rose after inflation unexpectedly accelerated.

“The mantra of the central banks is the same: We made progress, but we need to make sure inflation doesn’t back up again,” said Gregory Faranello, head of US rates at Amerivet Securities.

“Financial conditions have loosened dramatically. They are pushing back, and the market is listening,” he said.

European stock markets joined in the sell-off. Ms Lagarde's "more hawkish tone" on the prospect for early cuts in interest rates spooked stock investors, said Chris Beauchamp, chief market analyst at online broker IG.

"Investors finished 2023 on an exuberant note regarding potential rate cuts, but the theme this month is one of those expectations being radically dialled back," Mr Beauchamp said.

"For the Dow, S&P 500 and Nasdaq, which have essentially gone sideways this month, this hints at a more substantial pullback, but for European markets an even bigger correction now seems likely,” he said.

However, Capital Economics has predicted that the S&P 500 — the index tracking the largest companies in the US — will nonetheless "soar" this year.

"Our analysis leads us to conclude that, provided the economy skirts a recession, there is scope for a bubble to inflate in the S&P 500 this year and next," said John Higgins, chief markets economist at Capital Economics.

"We envisage the index becoming even more top heavy in the process, but do think that most sectors will fare well even if those that stand to benefit the most from the advent of AI keep leading the charge," he said.