Investors in Christmas celebration
The US central bank really handed out large Christmas gifts on Wednesday the 13th of December. The result of the monetary policy meeting was to keep the rates at a long-term high. However, the comments from the Federal Reserve Bank (Fed) were the reason for the cheer in the financial markets.
Maybe the cheers are so loud because it, after all, was a surprise that the Fed already turned around and is outright pointing at rate cuts next year. Based on the communication, it seems that the central bank’s own expectation is three rate cuts of 25 basis points each.
The breaking news even had a double-whopper dimension. Until recently, a number of Fed monetary policy members have indicated that another rate hike was an option. This is apparently called off and the Fed is looking downwards again.
Resetting back to lower rates
The typical work methodology is to keep the same interest level for a long time before the tide changes. This time, the Fed obviously just waited until the inflation seemed to be under control, which is the case now. Thus, the speed is a nice surprise for the investors.
We consider it somewhat of a turnaround surprise with the addition to the indication of the three cuts in 2024. Some market participants already had started to speculate on a change in the Fed’s standing at some point in the future, but it was not a large part of the market. We have advocated for this market speculation to come but also to intensify more before the Fed decides to turn around its rate policy. Here, we consider the Fed to have moved much faster than expected, which is the real surprise.
It can easily be that the financial markets are far from convinced about the strength of the American economy. We fully understand the arguments for the bearish view. Graph one shows that the credit sector is experiencing difficulties with the banks’ tighter lending standards and weaker demand for property loans.
This bearish view, we argue, will be counterweighted by the current move in the US fixed income market. The commencing dropping interest rates across the bond markets have been going on for the past 1½ months and even a measurable move, particularly in the US. However, we regard the shift in the Fed’s stance as so significant that it will continue to move the fixed income markets further. Right now, we expect the coming market move to become as big as the move during the past 1½ months. In total, it will send American rates back to the level from mid-2022.
It corresponds with our original expectation – which was a reset of the interest rates to a lower level – but it is not a new trend with the ongoing falling rates over the years. The consequence is a temporary happiness in the financial markets as long as the interest rates are resetting lower.
The extreme monetary tightening cycle has led to an inverted yield curve for Treasury bonds as seen in Graph two where short-term rates are materially higher than long-term rates. This opens up for the bears to worry because historically it has indicated an economic downturn. But it is right that one can argue the Fed is keeping short-term rates too high and we certainly are also observant about if cash becomes scarce.
Actually, investors can have to deal with the peculiar development that the yield curve steepens further in the coming six months. If the inflation drops faster than the Fed acts with rate cuts, then investors will price in the lower inflation in the long end of the yield curve; thus, the curve steepens. But it is not an economic growth predictor – it’s simply a move in the financial markets.
Most of it is what we would call a financial joy. The American economy will react positively to the lower interest rate though we don’t expect household consumption to jump nor do we think that the private sector investments to reverse strongly. But the housing market is worth keeping an eye on.
Economic Christmas gift in the US
Just a few months ago, the American 30-year mortgage rates were trading at almost 8 per cent; now, they are below 7 per cent after Fed’s turnaround. Naturally, this means a lot for the whole housing market in the US, but when the rates drop below 6 per cent, it starts to get interesting.
The majority of the mortgage loans at American households have fixed their loans between 5 and 6 per cent. If the 30-year mortgage rates move down to that area again, then we expect the activity to increase in the housing market; it could even be significant. If this scenario comes true, then the lower rates start to generate real economic growth.
As mentioned, we currently consider the current festive mood in the financial markets as limited to investors’ joy. It will require somewhat lower rates to spark the economic growth in the U.S. Further it is predominately an American economic Christmas story.
A real positive macroeconomic effect could be a possibility at some point during the second half of 2024. We are not considering a small uptick in the economy but a widespread economic forward move that even might be measurable globally. It’s too early to call it our clear primary scenario, but together with the highly stable economic growth in more Asian regions, the US could close the global economic growth gap later next year.
