Christmas has come early on stock markets

The US central bank offered the markets an early Christmas present at its meeting on 13 December. With its confirmation that we have probably reached the end of the cycle of tightening, it loosened the reins of its restrictive monetary policy. The US Federal Reserve thus unleashed a festival of green lights that rolled across the screens of investors.

Given the recent easing in rates on markets – which has effectively relaxed financial terms – there were some worries that the Fed’s tone would remain relatively restrictive due to fears that markets were getting ahead of themselves. But there was no hint of such dark forebodings in Fed statements.

Better still, Fed Chairman Powell’s tone during the question and answers session proved remarkably accommodative, in particular, highlighting the FOMC’s specific focus on the inherent risks of persistently high rates over a prolonged period.

The update of the dot plots projecting FOMC members’ forecasts for rates also reassured the market. They now expect an overall fall of 75 basis points in key rates in 2024, and a drop of 175 basis points by the end of 2025. This represents an additional 25 basis points versus the September forecasts.

Expectations for underlying inflation have also been revised down to 3.2% for 2023 and 2.4% for 2024, versus 3.7% and 2.6%, respectively, in September. This is a stunning change in forecasts since September, as the Fed Chairman emphasised, seeing this as the payback for the efforts of the central bank. Meanwhile the growth outlook remains clearly positive, albeit with a slight downwards revision for 2024.

In the wake of this reassuring news from the Fed, investors expected a similar tone from the European Central Bank (ECB) meeting on the following day.

However, the tenor of statements from Europe was much less accommodative. Despite weakening growth expectations of 0.8% for 2024 versus the 1% projected in September, despite Germany – on the brink of recession – ramping up its fiscal rigour, and despite inflation forecasts also being revised down, the ECB President confirmed that the committee had not begun any discussions whatsoever on lowering rates.

In contrast, the Fed is already indicating a series of rate cuts in 2024. Why is the ECB being so timid?

In contrast to the Fed, employment – and therefore growth – is not part of the ECB’s mandate. The requirement to take action in response to economic activity is therefore lower. But we believe that any delay by the Europeans in easing monetary conditions over the coming months would constitute a major monetary policy error. The growth differential versus the US would rise further. This is a prospect that could put a dampener on the early festivities started across the Atlantic.

Final version of 15 December 2023 by Olivier de Berranger, Deputy CEO and CIO, La Financière de l’Echiquier