Financial Markets Weekly Recap: Central banks on the move

Last Monday, the Nasdaq temporarily surpassed the 20,000 mark, marking a new milestone. Strong economic growth, increasing corporate earnings, moderate inflation, and the beginning of central bank easing have been the stock market’s winning formula this year. There is still some doubt regarding central banks’ next course of action as the fourth quarter inflation improvement is halting.

November CPI: A mixed bag, but some encouraging news

Not worse than anticipated before this week’s Fed meeting, the November CPI was the final important data point, and there was considerable anxiety about the possibility of an upside surprise ahead of the data release. The results, however, were exactly as anticipated, indicating that although the rate of inflation reduction has slowed, it is not poised to turn significantly. For the third consecutive month, core consumer inflation—which does not include the erratic prices of food and energy—rose by 0.3%, maintaining the annual rate at 3.3%. The rate of price increases is still higher than the Fed would prefer, but it is half of the 6.6% peak in 2022.

Food and fuel contributed to the headline CPI’s little increase to 2.7% from a year ago, the first consecutive annual acceleration in eight months. Prices for automobiles, furniture, hotels, and travel rose more quickly outside of those categories, probably due to the robust consumer spending that is still going strong (the recent hurricanes also contributed to higher demand and prices for autos). Based on more difficult comparisons from a year ago, known as “base effects,” we anticipate inflation to move marginally higher over the following two months, but we don’t believe that would signify a shift in the overall trend. Leading indicators, such as prices paid by service and manufacturing companies, indicate some persistence rather than a second wave of inflation.

Inflation data greenlights December Fed cut, signals caution for 2025

Fed could decrease its policy rate this week notwithstanding the statistics from last week. Neither the producer price index nor the consumer price index showed any significant surprises, and the increase in unemployment last month supported the policymakers’ belief that the labor market is no longer a source of inflation. The bond market is already pricing in a 95% chance of another quarter-point drop in December, even though the September Fed estimates suggested two more cuts this year, one of which was delivered in November.

No rush next year – However, as we enter 2025 the Fed will likely slow its pace of easing, as uncertainty around the path of inflation rises. Progress on disinflation has slowed, and potential changes in fiscal, trade and immigration policies may complicate the Fed’s effort to reach a neutral rate, a level that’s neither restrictive nor stimulating for the economy. Fed’s updated December interest-rate projections (the dot plot) may shift slightly higher, projecting a shallower easing cycle ahead, as both growth and inflation have been stronger than expected since September. We are looking for two or three rate cuts in 2025, with the fed funds rate settling in the 3.5% – 4% range by the end of the year.

There are justifications for other central banks to expedite their transition to neutral policy

Bank of Canada (BoC) is at the forefront. Last week the BoC cut its policy rate by half a percentage point to 3.25%, the high end of its 2.25%-3.25% estimate for the neutral rate. Over the past six months the bank has cut rates by 1.75%, faster and deeper than any other advanced economy. Since the population has been growing faster than jobs, core inflation is within the BoC target range, and economic growth in the fourth quarter has been weaker than anticipated, unemployment has increased to a two-year high of 6.8%. These factors all point to the need for policy to move out of restrictive terrain. But now that rates are close to neutral, authorities are indicating that they will scale back rate reduction and proceed more slowly.

As expected, the Reserve Bank of Australia (RBA) decided to leave its cash rate target unchanged at a 13-year high of 4.35%. It has now been more than a year since the RBA’s last rate move, the 13th increase in a series that began in May 2022. It also kept the interest rate paid on Exchange Settlement balances unchanged at 4.25%, UOB Group’s Economist Lee Sue Ann notes.

The European Central Bank (ECB) recognizes the possibility of negative outcomes. As anticipated, the European Central Bank lowered interest rates by a quarter percent last week. The bank’s policy rate has decreased by one percentage point to 3% following four rate decreases this cycle. In contrast to the US, markets are beginning to factor in a significant rate-cutting cycle for the upcoming year as growth and inflation projections are being revised downward. The biggest rate decrease in almost ten years occurred in Switzerland, where the central bank shocked markets by lowering its policy rate from 1.0% to 0.5%.

US dollar strength reflects divergent outlooks – With swifter rate cuts abroad, the difference between domestic and international interest rates is providing a boost to the dollar against a basket of other major currencies. From an economic standpoint, this can make imported goods cheaper, helping US inflation moderate. From a portfolio standpoint, international stocks tend to underperform during periods of a strengthening dollar, supporting our view that US stocks are well-positioned to continue to lead.

Entering a more uncertain phase, but the winning formula remains intact

Direction is clear; speed and depth up for debate – Heading into 2025, it is clear that the direction of travel for interest rates is lower, but the speed and depth of rate cuts is more uncertain. Unlike this year where the Fed and others delivered larger rate cuts, the pace will likely slow, as central banks try to balance cooling but still above-target inflation with a resilient economy and labor market. The Fed does not want to overstay its welcome in restrictive territory, risking an economic slowdown, but at the same time there are no reasons for urgency in normalizing policy.

Commodities

Crude oil prices have recently seen a surge, pushing crude oil futures above the $70 per barrel mark. While this upward trend is fueled by factors like OPEC+ production cuts and geopolitical tensions, a closer look reveals a more complex picture.

The recent rally in oil prices is a testament to the delicate balance between supply and demand dynamics in the global energy market. OPEC+ production cuts have undoubtedly played a significant role in supporting prices. However, the looming threat of increased US oil production, particularly under the potential influence of a pro-drilling administration, could temper this bullish sentiment.

The US dollar’s strength, as indicated by the US Dollar Index (DXY), also exerts downward pressure on oil prices. A stronger dollar makes commodities, including oil, more expensive for foreign buyers, potentially dampening demand.

While the short-term outlook for oil prices remains uncertain, it’s crucial to consider the long-term implications of various factors. The potential for increased US oil production could lead to a supply glut, which could put downward pressure on prices. Additionally, global economic conditions, particularly in China, a major oil consumer, could influence demand.

Gold, often considered a safe-haven asset, has recently faced headwinds as rising US Treasury yields and a stronger dollar have weighed on its price. While geopolitical tensions and economic uncertainties could provide support for the precious metal, the Federal Reserve’s monetary policy decisions will play a crucial role in shaping its future trajectory. The precious metal is trading at $2,655.24, down almost 1% for the day.

The Fed’s Impact on Gold

The Federal Reserve’s stance on interest rates has a significant impact on gold’s investment appeal. Higher interest rates increase the opportunity cost of holding non-yielding assets like gold, as investors can earn higher returns on interest-bearing investments. Conversely, lower interest rates can boost gold’s attractiveness as a safe-haven asset.

As the Federal Reserve prepares to make its next interest rate decision, investors will be closely watching for clues about the central bank’s future monetary policy path. A more dovish stance, including potential rate cuts, could provide support for gold prices. However, a more hawkish stance, with higher interest rates and a tighter monetary policy, could put downward pressure on gold.

Geopolitical Tensions and Economic Uncertainty

Geopolitical tensions, such as those in the Middle East and Eastern Europe, can also influence gold prices. In times of uncertainty, investors often turn to gold as a safe-haven asset to protect their wealth. However, the impact of geopolitical events on gold prices can be unpredictable and depends on a variety of factors, including the severity of the crisis and the market’s perception of the risks involved.

Economic uncertainty, such as concerns about inflation, recession, or financial market instability, can also drive demand for gold. In times of economic turmoil, investors may seek to diversify their portfolios and reduce risk by investing in gold.

Bitcoin

Since yesterday, the price of Bitcoin has risen by 0.42%. The price has increased by 2.89 percent in the past week. The price of Bitcoin is trading sideways on the hourly chart, indicating that neither buyers nor sellers are in control. The volume has decreased, indicating that there is no longer any energy from bulls or bears. Overall, it is more likely that tomorrow will see consolidation around the small band of $101,600–$102,600. The leading cryptocurrency’s rate has produced a false breakout of yesterday’s bar peak of $102,638 over a larger time period. One can anticipate a local correction to the $101,000 zone if the daily closure occurs far from that threshold.

The Week Ahead:

The Federal Reserve will announce a decision on interest-rate cuts this week, with investors anticipating that the central bank will again lower borrowing costs.
Remarks from Fed Chair Jerome Powell on Wednesday will give further insight into the future path of interest rates and the economy.

Investors will also be watching for reports on inflation, retail sales, GDP, home sales, and consumer confidence. Earnings reports are scheduled from chipmaker Micron Technology, apparel seller Nike, and package delivery service FedEx.