A Subdued Start to 2024
Financial markets generally enjoyed a strong end to 2023 fuelled by hopes of early and substantial interest rate cuts in 2024. However, they have seen a more subdued start to the new year with bond yields up in the UK, US and Eurozone in the first week of 2024, while most equity markets are lower.
Meanwhile, in currency markets the US dollar is generally higher, while sterling is up modestly versus the euro. These market moves represent only a partial reversal of the moves seen late last year but nevertheless do highlight the key issue of the moment for markets, namely whether their expectations for path for interest rates too optimistic. Markets have reacted by pushing out their previous hopes for Q1 rate cuts, particularly in the US and the Eurozone, but continue to look for them to fall significantly in total this year. In the US, a first cut is now discounted by May and rates are expected to fall by more than 125 basis points in total during 2024, with a similar outturn for the Eurozone.
For the UK, a first cut is fully priced for June with just under 125bp of cuts for the year as a whole. So far, policymakers at the Bank of England and the European Central Bank have been providing little support for those expectations. There has been no comment from BoE officials so far this year but the message in late 2023 was that rate cuts were some way away. Similarly, while ECB policymakers have been prepared to say that interest rates have probably peaked, they have confirmed that they have not yet even begun to talk about when they are likely to be cut. More positively for markets,
US Federal Reserve policymakers do seem to be willing to talk about the likelihood of rate reductions this year. The minutes of the December Fed policy meeting were released this week and they confirmed that the majority of US ratesetters expect rates to come down this year.
UK GDP AND US INFLATION TO BE IN FOCUS
Two indicators stand out in an otherwise relatively light calendar for the coming week. UK GDP fell by 0.3% in October which increased the odds o f a decline in Q4 as a whole. Given that Q3 has been revised down to show a small fall that would meet an oft-used definition for a technical recession (at least two consecutive quarters of negative growth). The output decline in October was broad -based with construction, manufacturing and services activity all down. However, the Official National Statistics have noted that much of the fall may have been linked to very wet weather (it was the equal 6th wettest October on record) rather than underlying economic trends. As weather conditions were more normal in November we expect there was a rebound in activity. Some Indicators, including stronger-than-expected rises in both retail sales and PMI services index, point to this and we forecast a 0.3% monthly rise. That will significantly lower the odds of a Q4 fall in output.
The bigger picture for UK economic activity is that it seems to be broadly flat with the 3-month growth rate for GDP currently at 0.0%. That supports the view that UK interest rates have peaked but with the economy still skirting recession and , given other conflicting data trends, also helps explains why the BoE is in no hurry to lower them. Also out in the UK next week is the British Retail Consortium’s measure of retail sales for December which will provide a signal of the strength of the Christmas shopping period.
US gasoline prices continued to edge down in December which should help produce only a small rise in monthly CPI inflation of about 0.1%. However, the fall in energy prices is unlikely to match the one that took place in December 2022 and so the annual rate of inflation is expected to accelerate modestly to 3.2% from 3.1%. Core inflation is forecast to rise by 0.3% for the third month in a row but that will still allow the annual rate to drop to 3.9% from 4.0%. There are a number of conflicting trends in recent US inflation data but overall goods inflation has decelerated sharply while services inflation is sticky. The Fed is likely to be reasonably happy with the situation but will probably see no need to rush rate cuts. Also of interest next week will be Chinese CPI data for December, which will show deflation continuing in the world’s second largest economy.
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