Fed lines up 3 rate cuts in 2024

The Federal Reserve kept the Fed Funds rate at 5.5% on the upper bound at its December meeting. The Fed noted that “economic activity has slowed” in recent data while “job gains…remain strong.” The only other change to the Fed’s statement was to water down the prospect of further rate hikes by tweaking the language to “any additional policy firming.” In its summary of economic projections the Fed revised up its GDP growth forecast for 2023 to 2.6% from 2.1% previously and marginally reduced its outlook for 2024 to 1.4% from 1.5% in the September SEP. The Fed also cut its forecast for inflation, expecting PCE inflation at 2.8% for this year, down from more than 3% previously and sliding to 2.4% in 2024, still ahead of target, before easing to the 2% target level by end of 2025. Headline PCE inflation was at 3% in its most recent print for October.

In its outlook for rates, the dots plot implied 3 25bps cuts from current levels to take the Fed Funds rate to 4.75% on the upper bound by the end of 2024, exactly in line with our own expectations. Fed chair Jerome Powell said that Fed was “aware of the risk” in keeping policy too tight for too long and that the Fed didn’t need to wait until inflation returned to 2% before it began cutting rates. Unlike its prior dots plot, no policy maker sees the need for rates to go higher with the one dot at 6.125% removed entirely. Overall the December FOMC is in line with our view that the Fed will be less aggressive on easing than markets are currently implying but that they will nevertheless begin cutting rates next year. Our call for rate cuts to begin midway through 2024 and then proceed on a quarterly sequential basis remains intact provided there is no material deterioration in economic conditions.

COP 28 concluded in Dubai with agreement on the Global Stocktake. The agreement called on nations to transition “away from fossil fuels in energy systems, in a just, orderly and equitable manner” in order to achieve global net zero emissions by 2050 “in keeping with the science.” It also called on nations to triple renewable energy capacity by 2030 and accelerate the “phase-down of unabated coal power.” How countries transition their energy systems away from fossil fuels will be determined individually and on a voluntary basis. The agreement also “recognizes that transitional fuels” can help in the energy transition which gives space for natural gas to replace coal in many economies.

The UK economy shrank in October according to a monthly estimate of GDP, dropping by 0.3% m/m compared with growth of 0.2% in September. The decline was concentrated in services industries which fell by 0.15% m/m. Industrial production in the UK also declined, down 0.8% m/m. The monthly GDP number was the slowest since July this year and gives more evidence to a UK economy that seems to be drifting amid still high inflation and elevated borrowing costs.

Industrial production in the Eurozone contracted in October by 0.7% m/m, sharper than market expectations and brining the annual measure down 6.6% from October last year. Capital and intermediate goods both contracted last month while energy output and durable consumer goods expanded. At a national level, output in Germany improved with only a 0.1% contraction m/m compared with almost 2% in September while France recorded a drop of 0.3% m/m after 0.6% a month earlier.

Today’s Economic Data and Events

• 10:00 SR CPI y/y Nov
• 16:00 UK Bank of England Bank Rate: forecast 5.25%
• 17:15 EC ECB Deposit facility rate: forecast 4%
• 17:30 US Retail sales m/m Nov: -0.1%

Fixed Income

• Markets interpreted the December FOMC as a dovish stance given the Fed outlined 3 cuts to policy rates for 2024. Yields on the front end of the curve tumbled with the 2yr UST down 30bps at the close to settle at 4.4265% while the 10yr settled lower by 18bps to 4.0164% and it is extending its move to below 4% in early trade today, its lowest level since July 2023.
• Futures and options markets have aggressively repriced rate cuts for next year after slashing their expectations following the stronger than expected nonfarm payrolls for November. The chance of a first cut in March has a greater than 90% probability according to market pricing with further cuts to follow over the rest of the year to 6 in total. That scale of easing still looks too aggressive to our assessment of current economic conditions and the outlook for next year where growth is set to slow but not collapse.
• Bond markets generally soared in the wake of the FOMC statement with the Bloomberg high-yield and EM indexes up 0.6% and 0.7% respectively. Local credit markets were green across the board with an index of GCC wide USD bonds up 0.3%.
• Moody’s affirmed their ‘C’ rating on Lebanon with a stable outlook.

FX

• The dollar was pummeled by the Fed’s apparent dovish stance at the December FOMC and the greenback lost ground against all peers overnight. USDJPY saw the biggest move with the pair down 1.8% to the favour of the yen, settling at 142.89. EURUSD gained 0.7% to 1.0874 ahead of today’s ECB meeting where we expect no change while GBPUSD was relatively more muted, with just a 0.4% gain to 1.2618.
• Commodity currencies were also positive with a 1.6% in AUDUSD to 0.6662 and USDCAD dropping by 0.5% to 1.3518. NZDUSD added about 0.7% to 0.6175 and is up nearly 1% in early trade today.

Equities

• Equity markets jumped in response to the Fed outlining more rate cuts than they had previously with the Dow Jones, S&P 500 and NASDAQ all up by about 1.4%. European markets had closed ahead of the FOMC statement and so settled mixed with EuroStoxx down about 0.1% and the FTSE gaining by about the same amount.
• Regional markets were relatively quiet yesterday with the Tadawul up by less than 0.1% and the DFM marginally higher. The ADX ticked slightly negative.
• Asian markets have generally opened positive in early trading today with both the Hang Seng and mainland indices higher. The Nikkei by contrast is lower by about 0.4%.

Commodities

• Oil prices gained overnight with front month Brent futures up 1.4% to USD 74.26/b and WTI adding 1.3%. EIA data showed a draw in US crude inventories last week of 4.3m bbl, offset to a degree by modest builds in gasoline stockpiles and a larger increase in distillates. Oil production was stable at 13.1m b/d according to the EIA.
• OPEC left its oil demand growth forecasts for 2024 unchanged at 2.25m b/d with almost 2m b/d of growth coming from emerging economies. The forecasting arm of the producers’ alliance also revised its non-OPEC supply growth forecast downward marginally to 1.37m b/d. The consistent expectation of healthy demand growth for next year follows voluntary cuts to production announced from some OPEC+ members at the end of November. With the OPEC projections for supply and demand next year and taking into account the voluntary cuts, OPEC is estimating that markets will be substantially undersupplied in 2024.
• The IEA publishes its oil market report later today where it is likely to include a much softer demand outlook than OPEC implies.
• In the wake of the Fed, gold markets added 2.4% to USD 2,028/troy oz with even bigger moves in silver prices. Industrial metals were more moderate with LME aluminium the only notable gainer.