March was supposed to be the month of the first interest rate cut in the US and in Europe. But given the latest macroeconomic data, as well as comments by senior officials of the central banks, this view is now completely abandoned. The issue which arises is that the equity market rally which started in late October of last year was primarily based on the notion that the FED and the ECB will cut rates by about 150bp this year, as inflation is falling fast. And "bad news are good news", under this line of thinking, because bad macroeconomic data enhance the probability of aggressive rate cuts, a catalyst which has worked very positively for markets for the last ten years or so. Paradoxically, strong economic data are taken negatively by markets because they will make the central banks hesitant to cut rates. Just two months into the new year and we can clearly say that for now, there is no visible sign of a recession in the horizon, although various data points show that this should have already taken place. Hence, we cheer the fact that the economies are still "hanging in there", but we are curious to see how markets will react if they realize that there might not be any rate cuts this year after all, although this is a distant possibility.
The ECB is the first to meet on Thursday and no change in rates is expected. But, the central bank's forecasts of growth and inflation are expected to be lowered in their new macro projections. We will also pay attention to Mrs. Lagarde press conference for any signs which could leave the door open for a first rate cut in early summer (June). The market is pricing a very small probability for a rate cut in April, but almost a certain 25bp rate cut by June. The same holds true for the FED , whose March meeting is on the 20th of the month. The market is now pricing less than 100bp of rate cuts and is approaching the FED's own projection of 75bp cuts this year. We would argue that for the equity markets a 75bp cut would be more preferable than the 150bp originally priced in, as the former is considered an "insurance cut" within the realms of a healthy but slow economy, while the latter would be a run-to-the-rescue move to make an imminent recession less severe.
Eurozone February inflation fell, but less than expected. The headline number declined to 2.6%, slightly above expectations of 2.5% and lower than the 2.8% number registered in January. Core CPI fell to 3.1%, missing expectations of a larger fall to 2.9% from the 3.3% level in the previous month. However, both numbers are now below 3% and potentially on their way to the 2% target of the ECB. The main driver behind the decline in inflation was the moderation of food prices (4% yoy increase). The fact that inflation is moving lower cannot guarantee that there will be no re-surge in the coming months especially if the labor markets remain as tight as they are now and wage growth continues to reside north of 4% in the US and close to 6% in Europe.
US inflation fell to the lowest level since early 2021, as measured by the PCE deflator. The Personal Consumption Expenditures metric is the FED's favorite gauge of inflation (despite the CPI attracting all attention). The Headline number was announced at 2.4%, down from 2.8% in December and Core fell to 2.8% from 2.9%. The Headline inflation is now 92% of the way to the FOMC's 2.0% inflation target from the peak increase of 7.1% in June 2022, and core PCE inflation is now 76% of the way to 2.0% from the peak increase of 5.6% in February 2022.
Swiss 4th quarter GDP increased more than expected. It was announced at 0.3% q/q (+0.6% y/y), while the details showed that services activity remained solid, while manufacturing was weak, as was forecasted by the recent PMIs. Private consumption accelerated to 0.3% q/q, driven by the services sectors, which benefitted from increased travel and inbound tourism. Goods consumption, however, was weak. Overall, Swiss real GDP now stands 6% above its pre-pandemic level, compared with 3% for the Eurozone.
Staying with the Alpine state, the Swiss National Bank President, Mr. Jordan, will step down at the end of September, after 12 years at the position. Jordan, 61, is widely seen as the intellectual powerhouse at the three-member SNB board and has a somewhat top-down leadership style, so the departure has created some anxiety. Switzerland’s federal government will appoint the next chair based on the recommendation of the 11-member Bank Council, which oversees and monitors the SNB. Press reports suggest the vice chairman, Martin Schlegel, 47, is the natural choice and since 1985, the vice chairs have been promoted to the main role. There would be a degree of continuity as Schlegel is seen as sharing Jordan’s mindset.
Talks about Europe's defense strategy continue unabated, and so is the interest of investors in the stocks of related companies. French president Macron hinted that Europe could send ground troops to Ukraine but he faced significant opposition internally and from EU leaders. The French foreign minister was quick to clarify that troops could be sent to Ukraine on training missions or to build weapons. German Chancellor Scholz clearly stated that NATO must not send troops to Ukraine, setting a red line, while UK PM Sunak also distanced himself from Macron's stance. At the same time the EU Commission President said that "Europe must spend more, spend better and spend European". Industry Commissioner Thierry Breton will unveil this week a new European Defense Investment Program (EDIP) worth at least 1.5bn EUR.
Europe's broad equity indices and the S&P500 moved to new highs, but French and Swiss stocks stalled. The market is continuously concentrating on Europe's few stocks which have been dubbed as the region's super-7 or magnificent-7, as well as on Germany's DAX index, which is the most liquid for hedge funds to gain quick exposure. This trend has left many other sectors and stocks unloved for the moment, but at valuations that are attractive and eventually will prove to have been great entry points for the longer term. Defensive sectors such as Healthcare and Staples fell by more than 1% for the week, as the riskier parts of the market were rallying.
US Treasuries cheered the good inflation data and bonds had a positive week. The US 10-year yield dropped to 4.18%, down from 4.30%, while the 2-year is approaching 4.50% again. Eurozone bonds did not move much as the progress on inflation was less pronounced. The German 10-year dropped to 2.40%, ahead of the important ECB meeting on Thursday.
Chart of the Week : High interest rates on high debt levels is a cause for concern.
Government debt as a percentage of GDP has skyrocketed in the last decade, with the need of providing pandemic-related relief making the fiscal situation even worse since 2020. Most major countries have now debt higher than their GDP, except for Germany which still employs a very strict fiscal policy and has managed to maintain its debt to lower levels than in 2010. This had not been really an issue for almost a decade, as interest rates in Europe were zero or negative and very low in the US. But since 2022 things have changed and the cost of servicing this debt has skyrocketed. It is no surprise that the US lost again its AAA rating this summer (Fitch) and it was downgraded to negative outlook by S&P. This situation is the main reason why we have held the view that fiscal policies must be adopted to a significant reduction of government spending which will have a negative impact on the economies, at a time when they are already slowing down.
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• Sources: Chart of the Week : Apollo , Photo: istockphotos.