Investors have been waiting for central banks to start cutting interest rates since the Federal Reserve announced its first rate hike of the cycle in March 2022.
Now it looks like it’s finally happening: For the first time since January 2021, the number of central banks cutting interest rates in November exceeded the number raising them, according to an analysis by Deutsche’s Jim Reid Bank.
This is certainly a promising development for investors who are encouraging central banks to achieve a “soft landing” of the global economy, according to Reid and Dario Perkins, an analyst at TS Lombard.
But before investors get too excited about the prospect that the Fed could join the party by mid-2024, they should keep in mind that hopes for a Fed policy change have already been wiped out, Reid said. And even if investors are right about the timing, they could still be wrong about the scenario of a soft landing for the economy.
See: Is the seventh time the charm? Here are the six other times the market wrongly thought there would be a dovish pivot.
“I would say that unless the United States experiences a recession, it will be difficult to see a major global easing cycle imminent. After all, inflation remains above target levels in major economies. However, if you get a recession, expect a huge turnaround in the first chart and bigger cuts than the market anticipates,” Reid said.
“What’s interesting right now is that the reductions are being packaged as part of a soft landing scenario. So I think they may be right for the wrong reasons, and you’ll end up seeing larger than expected reductions due to a harder landing than expected. Interesting times ahead.
Several central banks in South America have cut interest rates, including the central banks of Brazil and Peru. In Brazil and Mexico, central banks raised interest rates before the Fed. Now they are also beating the Fed to cut rates.
Investors may be tempted to celebrate the turning point in the global monetary policy cycle as confirmation that a soft landing is all but guaranteed. But according to Perkins, who outlined the change in a report shared with MarketWatch last week, that would be a mistake, even though inflation has shown signs of cooling in the U.S. and around the world.
“Unfortunately, the journey ahead remains perilous and both hard landing and no-landing scenarios remain in play,” Perkins said.
Here are three scenarios that TS Lombard says investors might want to keep in mind as they approach 2024 (the text below is taken directly from the Perkins study):
- Difficult landing: Weak demand is causing unemployment to rise and reflexivity to set in as spending and confidence continue to fall, which in turn hurts corporate profits and leads to another round of job cuts. jobs. The credit cycle deteriorates, adding another channel of reflexivity. These are the real dynamics of a recession; and when they begin, there is massive uncertainty about the ultimate size and duration of the economic downturn, which kills risk assets. Inflation will eventually subside, especially when there is “underemployment” in the labor market; but central bank easing will not immediately end the deterioration of the economy. The danger point for markets is the interval between serious macroeconomic deterioration and monetary response.
- Soft landing: Inflation is evaporating despite a generally solid macroeconomic environment. Unemployment is stable or increasing modestly, without triggering the reflexivity that defines the hard landing. Central banks either keep interest rates unchanged or carry out a 1995-style “mid-course correction,” returning monetary policy to a more neutral framework. Medium-term inflation risks are now roughly balanced and central banks are in no rush to return to monetary tightening. Growth resumes and the economic cycle continues, after a short interruption.
- No landing: Either inflation is not falling as quickly as central banks expect (to levels they are willing to tolerate, which are not necessarily 2%!), or it is reversing course, or it is expected to rebound the economic data base much stronger than expected. Far from reducing interest rates, authorities are forced to continue tightening monetary policy – perhaps after a brief pause. The recession that everyone expects in 2023 is simply postponed because the economy is still “overheating”, with the threat that further policy measures will lead to a more sustained (and perhaps more severe) downturn in 2024 Many economists would interpret “no landing” as a recession. a “delayed hard landing” possibly for 12 to 18 months.
The Fed began raising interest rates in March 2022 to combat the worst wave of inflation since the early 1980s. Since then, the Fed has raised its policy rate target from 0.25% to 5, 5%, while inflation fell from an annual rate of more than 9% compared to last summer to 3.2% in October, according to the latest CPI index data.
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