The usual thing in monetary policy is for central banks to move following the scheme leader-follower, a regime by which the US Federal Reserve, the main central bank on the planet, leads the rest of the central banks on the planet with its policies. The normal thing is that the US Federal Reserve always begins the processes of rate increases or cuts before the rest of the central banks, since they adapt to the measures taken by the monetary politicians of the main economy in the world. In this coming rate cut cycle Everything indicates that this situation will not occur, and that the ECB will lower the price of money before the Fed. This is what the market expects, and the long-term leading inflation indicators point in the same direction, confirming that The ECB is very close to meeting its goal, but the Fed still has work to do.
The 10-year inflation swap, also known as 5y5y, includes the inflation expectations that the markets have for the 5 years that begin five years from now. It’s one of the fetish indicators of central banks, since it allows them to know what inflationary pressure is expected in the long term, a measure that helps them make their monetary policy decisions with an eye on the distant future. Central banks usually refer to this indicator and, now, if they are guided by the situation in the US and Europe, everything indicates that the European Central Bank (ECB) is much closer to meeting its objective than the Federal Reserve.
In the United States, this inflation fetish index for the Fed is not giving good signals for the central bank. If in October the inflation swap began to weaken in the euro zone, and took it from 2.7% to the current 2.25%, in the United States it is resisting moderation, and has barely fallen to 2.5%, a level still too high for the Fed to afford to begin lowering interest rates. The different dynamics that long-term inflation swaps have had worsened in September 2023, widening the differential between both indicators to current levels.
The market expects the ECB cut first…
The reading left by the long-term inflation index is clear: inflationary pressures will be more intense in the North American giant in the future against the eurozone. Now that the problem for central banks is to control runaway inflation in the recent past, the ECB may be seeing this favorably, but the reality behind this indicator has a lot to do with an economy with worse prospects in Europe than in USA. The consensus of analysts that collects BloombergFor example, it points to very low growth for the euro zone, of 2.5% in real GDP (GDP discounting inflation) in 2023 and 2024, and rising to 1.4% in 2025, while for the US Forecasts point to real GDP growth of 2.5% in 2023, 1.6% in 2024 and 1.7% in 2025 for the United States.
With this scenario on the table, it is not surprising that markets now consider that it is more likely that the ECB will begin to cut rates before the Fed, since the weakness of the European economy will allow it, while, in the United States , there is more danger that an early rate cut will generate a further unwanted boost in inflation. Today Investors are buying that the ECB begins to cut rates at its meeting on April 1, compared to a Fed that would not move until a month later: The markets believe that the first cut from the US agency will arrive on May 1.
Markets have been slowly recalibrating their expectations for rate cuts for 2024, and these increasingly fit the scenario expected by the Federal Reserve itself. If at the end of last year investors bought up to 6 rate cuts of 25 basis points by the agency in 2024, now expectations indicate that there will be between 4 and 5 cuts this year, a scenario that fits much better with the forecasts of Fed members: in December, according to the Fed’s ‘dot plot’, American monetary policymakers expected 3 rate cuts in 2024. With an economy as strong as expected in the US and long-term inflation expectations as high, above 2.5%, it seems impossible to conceive that the Fed would embark on a rate cut as aggressive as was expected at the beginning of the year.
All of this also fits with the latest statements from a member of the Fed’s Federal Open Market Committee, Michelle Bowman, who has publicly acknowledged how “it is still too early to project when we are going to cut rates,” and believes that “it is not appropriate.” cut them in the immediate future. For Bowman, rates in the United States should remain at current levels for a while, “the appropriate ones,” in her opinion.
…but the release date in Europe is also delayed
Although the market already sees the ECB cutting rates before the Fed, it is also delaying the moment in which it expects the European body to make its move for the first time. Expectations of seeing six rate cuts in 2024 have been erasedand now they are leaning towards between 4 and 5 drops of 25 basis points this year, the same scenario as for the Fed, but starting the process a month in advance.
Christine Lagarde, the president of the ECB, left a less aggressive message than the Fed in the last meeting, and the market perceived it that way (Powell denied more firmly that a rate cut is near in the US, compared to Lagarde who reaffirmed her expectation of seeing a first cut already in the summer), the market continues to expect a rate cut in Europe sooner than the ECB itself indicates. And the organization has reasons to try to cool things down: last week it announced the launch of a new leading indicator of wage development in the euro zone (a fundamental element that the ECB now monitors to anticipate possible inflationary spikes), and the perspectives left by the new leading index also suggest that there is a risk that the rate cut could be delayed furtherpredicting that wage growth will still have some way to go in the coming months, and that the ceiling has not yet been reached in this regard.