Muzinich Weekly Market Comment: Cutting crew
Insight
December 16, 2024
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In our latest roundup of the key developments in financial markets and economies, we look back on an active week for central banks.
Last week saw significant central bank activity in Europe and Canada, many column inches devoted to a change of official language on monetary policy in China, and more evidence that the final push to get inflation back to target in the US will be challenging for the Federal Reserve.
It was a mixed week for credit markets; high yield outperformed, with Europe the standout, while US investment grade underperformed due to its sensitivity to Treasuries, where 10-year yields increased by around 20 basis points (bps). Major developed market equity indices were flat, while in commodities, oil prices increased around 5% after the European Union imposed new sanctions on Russian supply.[1]
ECB moves ‘a little bit’ closer to target
The European Central Bank (ECB) cut its key policy rate by 25bps to 3%, as expected, citing progress on disinflation but also its expectation for a “slower economic recovery”.[2] ECB staff forecasts for GDP growth in 2024 and 2025 were revised down slightly, to 0.7% and 1.3%, respectively. In its projections, which do not explicitly incorporate the potential impact of higher US tariffs, the ECB says recovery in the region “rests mainly on rising real incomes and firms increasing investment”.
In the press conference following the rate announcement, ECB President Christine Lagarde said that the timeframe for reaching its 2% inflation target has moved “a little bit forward” in 2025. Forward markets barely moved in response, with policy rates expected to continue to fall before reaching 1.75% in September 2025.[3] The long end of the yield curve rose, while the euro was down slightly versus the US dollar.
Bank of Canada and SNB go big
Elsewhere, both the Swiss National Bank (SNB) and Bank of Canada (BoC) announced 50bps cuts to their respective policy rates. The SNB cut rates to 0.5% on the back of lower-than-expected inflation and a weaker economic outlook.[4] It was the SNB’s biggest cut since 2015, during the heady days of negative rates.
A deteriorating economic environment was also the major reason behind the BoC’s decision to cut rates to 3.25%.[5] The country’s economy is particularly sensitive to interest rate movements. With unemployment at its highest level in 3 years, 6.8%,[6] and rising consumer credit delinquencies,[7] the BoC believed a bigger cut was justified.
Time to get loose
During what state media agency Xinhua described as a “crucial meeting” on December 9, the Chinese government’s politburo said it will take stronger measures to stabilize growth and meet the country’s economic challenges.[8] Particular attention was given to the change in official language on monetary policy, which moved from a “prudent” to “moderately loose” approach, the first time such wording has been used since 2011.
Whilst markets have been underwhelmed by recent fiscal policy announcements, the change in language should not be dismissed lightly. Chinese stimulus is purposefully intended to do “just enough” rather than “whatever it takes”, as former ECB President Mario Draghi famously promised in 2012 during the Eurozone’s sovereign debt crisis. The government wants to achieve its economic growth targets, but without fuelling a boom-and-bust cycle.
The change in monetary policy stance triggered major moves in Chinese government bonds, with 10-year yields falling to a record low of 1.77% last week (see Chart of the Week).
Another issue occupying the Chinese government’s attention is the possibility of another trade war with the US once Donald Trump begins his second term in January. During Trump’s first term, China responded to US tariffs by significantly weakening the yuan against the dollar. There is a growing expectation it will use the same tactic again, with Reuters reporting that the People’s Bank of China has “considered the possibility” of weakening the yuan by 3.5% from its current level.[9]
Of course, there are other tools to use during a trade war. Perhaps signalling he is prepared to fight fire with fire, Chinese President Xi Jinping got a head start on Trump by launching a probe into artificial intelligence giant Nvidia, banned exports of rare materials that have military applications, and restricted sales to the US and Europe of components used in the making of drones.[10]
You can ring my bell….
Donald Trump was in typically ebullient form on Thursday as he rung the opening bell at the New York Stock Exchange, with a ‘who’s who’ of Wall Street executives looking on. In a brief address, Trump promised to deliver “an economy the likes of which nobody’s ever seen before”.[11] And, in an interview with CNBC, Trump repeated his pledge to cut corporate taxes from 21% to 15%, but only for companies that manufacture in the US.
Meanwhile, the latest inflation data highlighted that the last leg of reaching the Fed’s 2% target is proving challenging. The Consumer Price Index increased 0.3% in November on a seasonally adjusted basis, haven risen 0.2% in each of the preceding 4 months.[12] Over a 12-month period, CPI has increased 2.7%, with food prices up 4%. The Producer Price Index for final demand increased 0.4%, largely on the back of a 0.7% increase in goods prices, while the price of services was up just 0.2%.[13]
These numbers are unlikely to deter the Fed from announcing a 25bps cut in the Fed funds rate on December 18 — the overnight interest rate swaps market is pricing in a 98% probability.[14] Nevertheless, there is growing uncertainty as to how many cuts it will be able to make in 2025 and debate over what the neutral rate of interest should be (one that will be supportive for the economy while keeping inflation stable).[15]
Fourth time lucky?
In our previous Weekly Market Comment, we reported on the political drama unfolding in France and South Korea, with the now ex-French Prime Minister Michael Barnier losing a no-confidence vote in parliament, which brought down his government, and South Korean President Yoon Suk Yeol’s short-lived imposition of martial law.
Events continued to unfold in both countries last week. In France, President Emmanuel Macron appointed his fourth Prime Minister of the year on December 13, with François Bayrou the latest in the hot seat.[16] Bayrou, leader of the European Democratic Party and the Democratic Movement, has unsuccessfully contested the presidency three times and is seen as an ally of Macron.
Barnier’s demise resulted from a failed attempt to push through an austerity budget without parliamentary approval, ostensibly to get the country’s deteriorating fiscal position back on track. If Bayrou had any doubts about the challenge that lies ahead, confirmation came in the form of an unscheduled change to France’s sovereign rating from Moody’s, which was cut from Aa2 to Aa3 on the same day as his appointment.[17]
Moody’s said the downgrade “reflects our view that the country’s public finances will be substantially weakened over the coming years. There is now very low probability that the next government will sustainably reduce the size of fiscal deficits beyond next year.”
Meanwhile, in South Korea, things went from bad to worse for President Yoon, with the country’s parliament voting to impeach him on December 14.[18] He is now suspended from his official duties, with his fate in the hands of the Constitutional Court. If the court decides to accept the impeachment motion, Yoon will be formally removed from office, paving the way for a presidential election.
This will be our final Weekly Comment until the new year. On behalf of everyone at Muzinich, we would like to wish you all happy holidays and a healthy and prosperous 2025.
Chart of the week: China government bond yields reach new low
Source: People’s Bank of China, as of December 13, 2024. For illustrative purposes only.
Past performance is not a reliable indicator of current or future results.
References
[1] Reuters, ‘Oil settles up $1 as EU agrees further sanctions threatening Russian oil flows,’ December 11, 2024
[2] European Central Bank, ‘Monetary policy decisions,’ December 12, 2024
[3] Bloomberg, ‘Market implied policy rates,’ as of December 13, 2024
[4] Swiss National Bank, ‘Monetary policy assessment,’ December 12, 2024
[5] Bank of Canada, ‘Bank of Canada reduces policy rate by 50 basis points to 3¼%,’ December 11, 2024
[6] Statistics Canada, ‘Labour Force Survey, November 2024,’ December 6, 2024
[7] FICO, ‘Average Canadian FICO Score Drops from 762 to 760,’ November 20, 2024
[8] Xinhua News Agency, ‘Key meeting signals stronger policy support to propel economic growth,’ December 10, 2024
[9] Reuters, ‘Chinese authorities are considering a weaker yuan as Trump trade risks loom,’ December 11, 2024
[10] Bloomberg, ‘Xi Readies Bargaining Chips for US Trade War,’ December 11, 2024
[11] CNBC, ‘Trump rings bell at NYSE to cheers of ‘USA’ as Wall Street CEOs, business leaders look on,’ December 12, 2024
[12] US Bureau of Labor Statistics, ‘Consumer Price Index Summary,’ December 11, 2024
[13] US Bureau of Labor Statistics, ‘Producer Price Index News Release summary,’ December 12, 2024
[14] Bloomberg, ‘Market implied policy rates,’ as of December 13, 2024
[15] Bloomberg, ‘Bond Traders Make Risky Bets on Neutral Rate ‘No One Knows,’ December 12, 2024
[16] Government of France, ‘François Bayrou appointed Prime Minister,’ December 13, 2024
[17] Moody’s, ‘Moody's Ratings downgrades France's ratings to Aa3; changes outlook to stable,’ December 13, 2024
[18] Bloomberg, ‘How the Impeachment of South Korea’s President Works,’ December 14, 2024
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