Dow’s record outruns central banks, counts on aggressive rate cuts

The Fed is likely to lead the easing cycle, and markets imply an 87 per cent chance of a move by March, followed by the ECB and Bank of England. Market timing suggests the New Zealand and Australian central banks will join in the second half.

Capital Group economist Robert Lind says the market is too optimistic about the prospect of rate cuts because of sticky inflation. “I’m more sceptical than the markets are about how far the Fed will be able to cut interest rates in 2024,” he said on Friday.

Brutal bond moves

There were brutal bond moves this week after the Fed updated its rate projections at its final policy meeting this year when it left its benchmark rate unchanged at 5.375 per cent, as expected, based on the mid-point of its band. The revised outlook suggested more rate cuts than previously outlined.

That sent global bond yields sharply lower, even though other major central banks, including the ECB and BoE, pushed back on rate cut talk on Thursday in a busy week for central banks. Policymakers indicated that rates would stay high for longer because of persistently strong inflation.

But hope for lower US borrowing costs lit a fire under stocks. European equities hit their highest level in almost two years, the Dow notched its second-straight record close in as many sessions, and Australian shares had their best day this year.

Yet, Deutsche Bank’s Mr Baker believes bond markets are too cautious on the Fed, predicting at least seven rate cuts next year.

“The Fed can do more than what they’re saying because we’re not convinced that the US growth story can keep outperforming, and it is going to slow,” he said.

Mr Lind said the Fed would not loosen conditions without evidence of succeeding in its inflation fight. “I think the Fed is likely to want to see confirmation that inflation is moving back towards target before it sanctions those rate cuts and that could well take most of 2024.”

Inflation cheer

Capital tips a soft economic landing, predicting a sustainable growth rate of about 1.5 per cent to 2 per cent through most of next year.

Across the Atlantic, traders imply Europe’s central bank will lower its 4 per cent deposit rate to just 2.4 per cent by the end of next year.

“Both the ECB and the BoE will cut rates multiple times in 2024, but we think markets have moved too aggressively at this juncture,” agreed Gavin Friend, a senior market strategist at National Australia Bank.

He expects the ECB to ease rates in April – in line with futures pricing – but predicts the benchmark will fall only to 3 per cent by December next year.

Deutsche Bank says the markets’ overall pricing for the eurozone is still reasonable, forecasting 150 basis points in cuts next year, starting with a lumpy 50 basis points ECB rate reduction in April.

National Australia Bank and Deutsche Bank predict three rate cuts by the BoE next year, taking the policy rate to 4.5 per cent by next December, compared with the 4.25 per cent implied by markets.

Mr Baker believes market pricing is a better guide than what central banks say and do. “The last thing they want is to have the market price run too far ahead and change what happens in the economy.”