News of the week summary - 04/28/2024

New growth and inflation figures threaten Biden's re-election chances

Data for inflation-adjusted growth figures turned out to be disappointing, with the first-quarter annual rate coming in at 1.6%, below analyst forecasts of a 2.5% rise. In addition, core inflation jumped to 3.7%, exceeding expectations. While President Biden had hoped for economic growth to bolster his position ahead of the election, borrowing costs remain at a 23-year high.

The President's hopes for a pre-election interest rate cut took a hit, as suggested by the fact that the new data led investors to adjust their expectations regarding the actions of the Federal Reserve. Initially anticipating a quarter-point reduction in interest rates by September, investors are now fully pricing in such a move only by the Federal Reserve's meeting on November 6-7, immediately after the November 5 presidential election.

Market expectations regarding interest rate cuts have fluctuated significantly in recent months, with some investors even betting on rate hikes by the Fed over the next year. Factors such as slowing growth and stubbornly high prices contribute to a complex economic landscape, with the Fed facing pressure to balance inflation concerns with the need for economic stimulus.

Furthermore, the impact of US policy decisions reverberates globally, influencing the decisions of other central banks such as the European Central Bank (ECB) and the Bank of England (BoE). While the ECB and BoE have signaled their intention to cut rates, they face challenges in managing their economies amidst divergent global economic conditions and potential currency fluctuations.

The BOJ stays the course despite the fall of the Yen

The Bank of Japan's (BoJ) decision to maintain interest rates and its apparent lack of urgency in addressing the yen's decline to a 34-year low have stirred speculation and market reactions. Despite the yen's tumble, BoJ Governor Kazuo Ueda stated that its weakness had "no major impact" on inflation, suggesting that monetary policy adjustments might not be imminent.

Investors, anticipating a potential intervention to support the currency, closely monitored the BoJ's actions. The central bank's stance reflects a complex balance between currency volatility, economic impacts, and inflationary pressures. While the BoJ is not directly targeting currency rates, it acknowledges the importance of monitoring their impact on the economy and prices.

When the BoJ lowers interest rates or implements policies to increase the money supply, it tends to weaken the yen by making it less attractive to investors seeking higher returns. Conversely, raising interest rates or reducing monetary stimulus can strengthen the yen by making it more appealing to investors. 

The yen's sudden fluctuations led to speculation about potential government intervention in the currency markets. However, the Finance Ministry's response remained ambiguous, leaving market participants uncertain about future developments.

The BoJ's forecast for inflation to remain near its 2% target for the next three years suggests a cautious approach to monetary policy adjustments. Governor Ueda signaled a gradual approach to future rate hikes, emphasizing the need for sustainable increases in prices and wages.

However, the weakening yen poses challenges, potentially accelerating inflationary pressures due to increased import costs. If the impact of the weaker yen becomes significant, it may prompt the BoJ to reconsider its monetary policy stance.

Eurozone business activity rises to a 1-year high

Eurozone business activity has surged to its highest level in almost a year, indicating a potential rebound from the recent economic stagnation, according to a widely followed survey of companies by S&P called the "Purchasing Manager Index" (PMI), which measures the health of various sectors within an economy by surveying purchasing managers at businesses. It indicates whether sectors are expanding or contracting based on factors like production, new orders, and employment. The survey indicates the growth in the services sector has offset weaknesses in manufacturing, and that there has been an uptick in price pressures as services companies passed on higher wage costs.

This positive survey is likely to reassure officials at the European Central Bank (ECB) that the eurozone economy is still on course for a "soft landing," avoiding a recession while inflation steadily declines towards its 2% target. S&P noted that companies reported slightly higher increases in selling prices compared to the previous month, driven by rising labor costs and increased energy and fuel prices, suggesting persistent inflation pressures.

Investors anticipate the ECB to begin cutting its benchmark deposit rate from its record high of 4% at its upcoming meeting on June 6. ECB Vice-President Luis de Guindos recently stated in an interview that this is now a quite certain as long as inflation remains subdued.

The eurozone PMI has been rising for six consecutive months, indicating a rebound after the economy stalled for much of 2023. However, there is a growing divergence between services and manufacturing sectors. While new orders for services companies have increased at the fastest pace since May last year, manufacturers have indicated a worsening two-year decline in demand in April.

Chief of Italian Central Bank favours aligning more closely the ECB's policy with the FED'S

In a recent speech, Fabio Panetta, the head of Italy's central bank, expressed concerns about the potential impact of the US Federal Reserve's monetary policy on global borrowing costs. Panetta suggested that if the Fed maintains or raises interest rates, it could necessitate additional interest rate cuts by the European Central Bank (ECB) rather than weakening the case for such cuts.

This view contrasts with warnings from other ECB policymakers against diverging too much from the Fed's stance. Recently, investors have adjusted their expectations for Fed rate cuts following comments from Fed Chair Jay Powell, indicating that borrowing costs may need to remain elevated for longer due to stickier-than-expected US inflation.

US inflation reached 2.7% in the year to March, surpassing economists' expectations, while core inflation has remained at 2.8% (see the first article of the newsletter). Some traders are now pricing in potential rate hikes by the Fed in the next 12 months. Concerns about a tighter Fed stance have led to an increase in bond yields in Europe, causing investors to revise down their expectations for ECB rate cuts this year.

Panetta emphasized the importance of considering the extent to which the ECB's policy can diverge from the Fed's, warning of the potential negative effects of failing to account for the strong spillovers from US bond markets to global markets. He highlighted the risk of unexpected monetary tightening if the Fed keeps rates unchanged despite market expectations for cuts, which could adversely affect inflation and output in the eurozone.