News of the week summary - 22/12/2024
Fed cuts rates but signals a more cautious approach ahead
The Federal Reserve has lowered its benchmark interest rate by 25 basis points (0.25%), bringing the federal funds rate to a range of 4.25-4.5%. This marks the third consecutive rate cut in the ongoing effort to tame inflation, but the central bank has signaled a slower pace of reductions in 2025 to balance inflation control with economic stability.
This cautious approach stems from concerns that reducing rates too quickly could jeopardize progress in bringing inflation down to the Fed’s 2% target. Inflation, measured by the core personal consumption expenditures (PCE) price index—which excludes volatile food and energy prices—currently sits at 2.8%, indicating slower progress in recent months.
The Fed projects the rate to decrease by only 50 basis points (1 basis point = 0.1 percentage point) next year, down from earlier expectations of a full percentage point cut. This tempered outlook highlights the challenge of determining a "neutral" interest rate—a level that neither stimulates nor constrains economic growth—while addressing inflation concerns.
Officials also revised inflation forecasts upward, predicting core inflation at 2.5% in 2025 and 2.2% in 2026. Meanwhile, unemployment is expected to stabilize at 4.3%, suggesting resilience in the labor market. This contrasts with earlier fears that rate cuts could disrupt employment and economic activity.
Despite the cuts being described as a "recalibration," the Fed’s language in its policy statement points to the likelihood of pausing rate reductions in the near term. Policymakers emphasized the importance of assessing incoming economic data and evolving risks before making further adjustments.
This decision occurs against the backdrop of a robust U.S. economy, which has given the Fed more leeway to focus on inflation. However, uncertainty looms as President-elect Donald Trump prepares to implement policies like higher tariffs, tax cuts, and deregulation, which economists warn could stoke inflation and potentially undermine growth. The Fed has not yet factored these policy changes into its projections, leaving the outlook uncertain.
Government shutdown debate highlights political risks
The tumultuous process of averting a U.S. government shutdown has given investors a preview of potential obstacles facing the incoming Trump administration. While markets remain largely unshaken, the standoff underscores how gridlock, driven by ideological divisions within the Republican Party, could amplify uncertainty and market volatility in 2025.
The immediate issue centers on President-elect Trump’s push to tie raising the debt ceiling to the spending bill. His proposal has met resistance from fiscal conservatives in Congress, who argue for reducing government spending. This intra-party conflict, combined with his negotiation style—which leans heavily on bold threats and last-minute demands—has raised concerns about the feasibility of his broader agenda, including fiscal stimulus, deregulation, and tariff policies.
This legislative deadlock coincides with market reactions to the Federal Reserve’s announcement of fewer-than-expected interest rate cuts in 2025. The uncertainty surrounding both events has contributed to fluctuations in equities, though investors remain optimistic about a resolution to the shutdown. Historically, government shutdowns average nine days, with minimal long-term impact on markets. The S&P 500, for instance, typically declines 0.3% in the week leading up to a shutdown but recovers once the event unfolds.
Friday's market performance reflected this resilience, with the S&P 500 climbing 1.7%, buoyed by cooler-than-expected inflation data. Still, investors recognize that prolonged fiscal battles could erode confidence in the so-called “Trump Trade,” which has propelled assets linked to his policy agenda.
The broader concern lies in the potential implications of this impasse for Trump’s economic priorities. His ability to pass significant fiscal measures, such as infrastructure spending or tax reforms, may face hurdles from Republican “fiscal hawks” demanding deeper spending cuts in exchange for debt ceiling adjustments. Such challenges could temper market optimism and complicate efforts to stimulate growth.
ECB’s Lagarde declares progress in inflation battle
European Central Bank (ECB) President Christine Lagarde announced that the “darkest days of winter” for high inflation appear to be over, signaling optimism in the fight against inflation and paving the way for further interest rate cuts. Speaking in Vilnius, Lagarde emphasized the ECB's commitment to reducing rates, a stance that aligns with market expectations of continued monetary easing into 2025.
Lagarde noted a sharp decline in inflation, which peaked at 10.6% in late 2022 but has since dropped to 2.3% in November. The ECB forecasts inflation will reach 2.1% in 2025 and stabilize at 1.9% in 2026, nearing the ECB's 2% target. Wage growth, a key inflation driver, is projected to decline from 4.8% this year to 3% by 2025, a level deemed compatible with price stability.
Despite this progress, Lagarde pointed out risks to growth and inflation, including weaker-than-expected economic recovery in the Eurozone. Economic growth forecasts for 2024 have been downgraded from 1.8% to just 0.7%. The contraction in business activity has shown signs of easing, with December's composite PMI rising to 49.5 from November’s 48.3. However, it remains below the critical 50-point threshold that separates expansion from contraction.
Lagarde highlighted geopolitical uncertainties, such as risks to investor sentiment and financial market stability, as potential challenges to the ECB’s monetary policy effectiveness. She stressed the need for continuous assessment of monetary transmission and cautioned that geopolitical shocks could disrupt the baseline inflation outlook.
The ECB has already lowered borrowing costs four times this year, with its benchmark deposit rate now at 3%. Analysts expect the ECB to continue cutting rates, particularly in light of subdued growth and easing price pressures.
Argentina comes back to economic growth
Argentina has exited a prolonged recession, recording 3.9% GDP growth in the third quarter of 2024 compared to the previous quarter, according to the country’s statistics agency. This marks the first quarter of economic expansion since late 2023 and represents significant progress for President Javier Milei’s ambitious economic reforms.
The year-on-year GDP comparison still reflects a contraction of 2.1% for the third quarter. However, the rebound aligns with Milei’s libertarian agenda to stabilize Argentina's economy through drastic austerity measures and aggressive deregulation. These policies have succeeded in reducing the country’s triple-digit inflation, earning international praise from figures such as U.S. President-elect Donald Trump and billionaire Elon Musk. Argentina’s sovereign bonds also rallied following the announcement, with the risk premium for its debt narrowing to 677 basis points, a marked improvement from over 2,000 when Milei took office.
Despite these gains, the path forward remains fraught with challenges. Argentina’s economic crisis, rooted in years of inflationary money printing to finance government spending, initially worsened under Milei’s administration. The inflationary pressures and spending cuts led to a surge in the poverty rate, which reached 53% by mid-2024. Even with the current rebound, deep structural issues persist. Currency and capital controls continue to deter foreign investment and limit the central bank’s ability to accumulate hard currency reserves. Additionally, while agriculture and mining exports are thriving, manufacturing and construction remain significantly depressed.
The third-quarter recovery was largely driven by a rebound in consumer spending and capital investment, alongside robust growth in the export sectors of agriculture and mining. However, analysts caution that sustaining this growth will require broader improvements in economic performance. JPMorgan projects Argentina’s economy will contract by 3% in 2024, but anticipates strong growth of 5.2% in 2025, which would return per capita GDP to 2021 levels.
For President Milei, maintaining this momentum will be crucial as he approaches midterm elections next year. His ability to deliver lasting growth and improve living standards will play a key role in his efforts to expand his congressional minority and solidify support for his economic reforms.
Yen falls as BOJ maintains policy unchanged
The Japanese yen weakened past ¥157 against the US dollar yesterday after Bank of Japan (BoJ) Governor Kazuo Ueda signaled caution regarding a potential interest rate hike. Ueda stated that the central bank required "one more notch" of information, citing ongoing uncertainties surrounding Japan's wage growth and the global economic implications of Donald Trump's incoming presidency.
The BoJ’s decision to maintain short-term interest rates at 0.25% was widely anticipated, but many economists had expected stronger indications of a hike in January. Ueda’s lack of commitment during a press conference caused the yen to fall sharply, sliding from ¥155 to over ¥156.6 during the event and later breaching the ¥157 threshold, marking its lowest level since July.
Ueda underscored the need for clearer data on Japanese wage trends and the potential effects of Trump’s fiscal, trade, and immigration policies. These insights, he noted, would take time to fully materialize, adding that Japan’s underlying inflation remained "very moderate."
The decision was further complicated by the US Federal Reserve’s recent move to cut rates by 0.25 percentage points while signaling a slower pace of reductions for 2025. This divergence in monetary policy dynamics added pressure on the yen.
The BoJ’s policy board was not unanimous in its decision. A member advocated for a rate increase to 0.5%, citing rising risks to inflation. The meeting also featured a review of Japan's 25-year monetary policy history, which has been shaped by deflation and unconventional strategies.
This year, the BoJ ended its eight-year experiment with negative interest rates, first moving to zero and then raising rates to 0.25% in July, a decision that disrupted currency and equity markets. While Ueda emphasized that unconventional policies were not off the table, the continued postponement of further tightening raises concerns among market participants.
As uncertainties linger, the yen's trajectory remains vulnerable to domestic wage dynamics and external geopolitical and economic factors, particularly U.S. policy directions under the Trump administration.
China's economic outlook darkened by US tariffs threats
Economists warn that China's export sector, a crucial driver of economic expansion, could face significant headwinds in 2025 as the incoming U.S. administration under Donald Trump threatens new tariffs on Chinese goods. This potential development adds to existing worries over the Chinese economy's slowing growth trajectory.
From January to November 2024, Chinese exports grew by 5.4% year-on-year in dollar terms, reaching $3.2 trillion. This performance bolstered GDP growth, even as authorities grappled with a prolonged property sector downturn and broader economic challenges. However, economists widely anticipate a deceleration in export growth next year due to the tariff threat, increasing the pressure on Beijing to implement measures to sustain its economic momentum.
Trump has pledged to impose a 10% tariff on Chinese goods, a reduction from earlier threats of 60%, though no formal decision has been made ahead of his January inauguration.
The expected slowdown (of around 1% for exports) comes at a critical juncture for China. At the recent Central Economic Work Conference, President Xi Jinping emphasized the need to boost domestic demand, signaling renewed urgency to maintain growth. Beijing has already introduced measures to support stock market prices and a local government refinancing package. However, recent economic data, including weaker-than-expected retail sales figures, underscore the challenges ahead.
The National Bureau of Statistics acknowledged the increasing complexity of the external environment. Despite these challenges, President Xi expressed confidence in achieving the official 2025 growth target of approximately 5%.