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SPI Management Newsletter 15.12.23

European Central Banks Hold Firm Amid Fed's Shift in Monetary Policy

European central banks are standing their ground against inflation, despite a dramatic policy shift by Jay Powell, chair of the US Federal Reserve. The European Central Bank (ECB) and the Bank of England are resisting the lure of rate cuts, even as investors speculate they might follow the Fed's lead in reducing borrowing costs in 2024.

This insistence on maintaining a tough stance against inflation comes amid a complex global financial landscape. Central banks can deviate from the Fed, but it's historically challenging to maintain a significant divergence for long. The Fed's recent dovish turn, signaling potential rate cuts next year, has sent ripples through global markets, raising stocks and bonds and fueling speculation about other central banks' next moves.

The ECB and the Bank of England, meeting for their final policy discussions of the year, have expressed caution. The ECB, in particular, was taken aback by the Fed's pivot, which could impact global bond yields and inflation rates. Despite these pressures, the ECB and the Bank of England are holding firm, with a focus on evidence of cooling job markets and easing price pressures before considering any policy shifts.

The Fed's adjustment was initially unexpected, considering the uncertain economic outlook. However, Powell's recent indication of a willingness to consider rate cuts next year, given inflation's move towards the 2% target, marked a significant change in direction.

Market reactions, however, suggest investors may overlook these messages. Current market pricing indicates anticipated rate cuts from both the Fed and the ECB next year, and possibly from the BoE as well.

A Fed rate cut would put additional pressure on the ECB by affecting the Euro-Dollar exchange rate and impacting export competitiveness and import prices in the Eurozone. Conversely, a bond market rally could boost Eurozone growth and prices, potentially making inflation more persistent. Despite the Fed's more growth-sensitive mandate, the ECB focuses solely on price stability, giving it less flexibility in adjusting rates.

HSBC Asset Management Forecasts a Shift in Global Markets and Bond Revival

HSBC Asset Management anticipates a significant shift in global markets, forecasting a "new paradigm" as the world faces a fragmented global order and increased recession risks. According to the company's 2024 investment outlook, stringent monetary and credit conditions are leading to a critical juncture for the global economy, with a potential for growth shocks that markets may not be fully braced for.

The firm predicts U.S. inflation will align with the Federal Reserve's 2% target by late 2024 or early 2025, with other major economies expected to see similar drops in their consumer price index figures. The expectation is that the Fed will initiate rate cuts in the second quarter of 2024, cutting deeper than the current market predictions for the rest of the year. The European Central Bank and the Bank of England are also expected to follow suit, with the latter starting its own cycle of rate cuts, albeit at a slower pace.

Given these conditions, economic downturns may become more frequent, limited by higher inflation that constrains central banks' ability to stimulate economies. The investment strategy for the next 12 to 18 months, as per HSBC AM, will focus on corporate profits, the debate over the "neutral" interest rate, and labor market and productivity trends.

HSBC AM's outlook also emphasizes the renewed importance of bonds suggesting that a combination of a weaker global economy and slowing inflation could create a favorable environment for government bonds, but pose challenges for equities. The firm sees potential in specific segments of global fixed income, including U.S. Treasuries, core European bond markets, and certain credits.

Regarding equities, HSBC AM advises caution on U.S. stocks due to optimistic earnings growth expectations and valuation concerns. European stocks, seen as relatively inexpensive, have limited downside unless a recession occurs. Japanese stocks might outperform in developed markets, favored by valuations, policy shifts, and domestic economic pressures.

In summary, HSBC Asset Management's outlook for 2024 envisions a change in global financial dynamics, with a renewed focus on bonds and cautious strategies in equities, considering various economic and geopolitical factors influencing the market.

Adapted from The Economist, FT, NYT, Reuters, CNBC, Bloomberg

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