Central banks: Rate hikes may be over, but hawkish words continue

This week will see a trifecta of central bank meetings: the US Federal Reserve (Fed), the European Central Bank (ECB), and the Bank of England (BOE). Behind the scenes, I suspect these central bankers are high-fiving each other, drinking punch, and eating cake because they have come to the conclusion they can have their cake and eat it too — that inflation can be tamed without sending their respective economies into a serious recession. (And they were right — inflation has been transitory, just not as transitory as many would have liked.) In front of the microphones, however, I expect central banks to maintain a more hawkish public face regarding interest rate hikes. 

We saw this dynamic play out last week with the Bank of Canada (BOC), which has been at the vanguard of Western developed banks in the last several years. The BOC met last week and decided to keep rates on hold (they haven’t hiked since July). In a nod to the progress it’s recently seen on inflation, the BOC removed this language from its statement: “…progress towards price stability is slow and inflationary risks have increased” However, it maintained a hawkish tone publicly, warning that “Governing Council is still concerned about risks to the outlook for inflation and remains prepared to raise the policy rate further if needed.” They also added that they wanted to see “a further and sustained easing in core inflation.”¹

That will be the playbook I believe the Fed, ECB, and BOE are likely to follow this week: no change in policy but an abundance of hawkish warnings that they stand ready to hike again if they don’t see further progress on disinflation. They are trying their best with their words to keep a lid on the easing of financial conditions.

The bottom line: I believe there will be no more rate hikes, and they will instead be thinking about when to start cutting.

Data shows continued progress on US disinflation

What makes me so confident? The data. It has shown continued progress on disinflation with economic growth slowing but still resilient — particularly in the US. Even the data we got last week shouldn’t stop the Fed from starting rate cuts in the spring of 2024:

• In the November US Employment Situation Report,² the economy added 199,000 jobs, above consensus expectations. At first blush, that might seem a little too strong. However, a significant portion of job creation came from the government. And those non-farm payrolls numbers were boosted by the more than 40,000 autoworkers and actors who returned to their jobs after strikes. In addition, there was a significant downward revision to non-farm payrolls for previous months. And while average hourly earnings increased by 0.4% month-over-month, I don’t believe it’s a cause for concern. The annual growth rate remained unchanged at 4.0%, while productivity has risen. I would characterize this as a rather benign jobs report that should do nothing to convince the Fed to hike.
• We also got the preliminary University of Michigan Survey of Consumers for the month of December.³ The results show a sharp drop in consumer inflation expectations for the one-year ahead period (as well as a material drop in the five-year ahead expectations). This was as I expected. You may recall that we got a recent spike in consumer inflation expectations, which was a cause for concern among Fed watchers because of the importance the Fed places on this measure. However, I believed this was just a repeat of what we saw last spring — a short-term spike driven by a rise in oil prices. Historically, oil prices have had an outsized impact on short-term consumer inflation expectations, and the recent spike appears to have been no exception. Now that oil prices have come down, it’s no surprise that inflation expectations have as well. The icing on the cake is that the same survey showed consumer sentiment had finally improved.

The eurozone and UK have also seen significant disinflation

We’re seeing a similar story in the eurozone and UK, where disinflationary progress has been significant. So much so that monetary hawk and ECB Executive Board member Isabel Schnabel said last week, “When the facts change, I change my mind…The most recent inflation number has made a further rate increase rather unlikely…The recent inflation print has given me more confidence that we will be able to come back to 2% no later than 2025."⁴

And the UK and eurozone economies are holding up despite the aggressive tightening cycle they have experienced. The S&P Global / Hamburg Commercial Bank eurozone composite PMI for November, released last week, hit a four-month high, although still well within contraction territory.⁵ I was particularly encouraged by the readings from Germany, as its economy has been under significant pressure. Germany Services PMI for November positively surprised, rising significantly higher than its October reading — and near expansion territory, clocking in at 49.6. ⁵ There was also a positive surprise in the UK; UK services PMI was an impressive 50.9, up from October’s 49.5.⁵

Anticipating a bumpy landing

Now having said all that, I do think these economies will experience a significant slowdown in the first half of 2024, as the aggressive rate hikes of recent past catch up with them. For example, we have seen a significant increase in US bankruptcies: commerical chapter 11 filings increased 141% in November 2023 from November 2022,⁶ which I think has a lot to do with tighter credit conditions.However, I think it will be a bumpy landing, not a hard landing, and I expect to see a re-acceleration in the second half of the year. (Learn more in our 2024 annual investment outlook.)

But the key takeaway is that I believe Western developed central banks are done hiking and are now concerned with when to cut, but I am also prepared for some hawkish public warnings — even if they are privately celebrating (and having their cake and eating it too).

Dates to watch

The data reports aren’t slowing down. See below for a list of what I’m watching. And on Dec. 13, join me on X, formerly known as Twitter, as I share my real time views of the Federal Open Market Committee interest rate decision and key takeaways from Fed Chair Jay Powell’s press conference as it happens.