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Investment Institute
Macroeconomics

Deferred Confidence

  • 05 February 2024 (10 min read)

  • Powell’s Q&A and the payrolls put paid to expectations of quick cuts by the Fed  
  • Euro area January inflation – with concerning developments in services – may have done the same for the ECB

In December Jay Powell had fuelled the already aggressive market pricing for quick rate cuts. Last week he chose to take the opposite posture and did so effectively. Beyond the explicit reference to March not being the FOMC’s base case for the first cut, Powell’s key point was the need to get further confirmation of the ongoing disinflation process to get the level of confidence needed to embark on cuts. While the FOMC chairman made it clear the Fed is not seeking a proper downturn of the labour market, seeing more normalisation there was on his shopping list. From this point of view, the strong payroll last Friday came as a strong warning signal.

Optimists will argue that if the reason beyond the resilience of the US economy is a positive supply-side shock pushing both employment and productivity higher, then one could be relaxed about the inflation risks. Still, the same configuration is also consistent with a higher equilibrium interest rate, while even the strong recent productivity gains could not fully offset the current wage momentum. We find similarities with the discussions at the Fed in the late 1990s when the New Economy narrative – at the time based on the impact of the new information technologies – convinced Alan Greenspan to “go easy” on monetary tightening. These decisions probably contributed to the build-up of imbalances ahead of the Great Financial Crisis of 2008. The risks are different today, of course, but this memory should be another reason for the Fed to be cautious.

Meanwhile, the Euro area does not have the luxury of discussing the possibility of a positive supply-side shock given the mediocrity of its latest GDP prints. We wrote last week that for the ECB to cut in April, a “perfect data flow” would be needed. The inflation print for January, with potentially concerning news for services prices, certainly does not qualify. All this leaves us comfortable with our baseline of the first cut coming in June on both sides of the Atlantic.  

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