Curmi & Partners

Central Banks to Remain Cautious

By Simon Gauci Borda

U.S. employment data released on Friday the 8th of December showed that the labour market remains robust. In fact, according to the non-farm payrolls report, a total of 199k jobs were added to the U.S. economy. While these figures came in above consensus, the three-month moving average, which smoothens out the month-on-month changes, remained stable at 204k. The additional jobs created were due to the unwinding of strikes that recently occurred. The increase in job numbers led to the decline of the U.S. unemployment rate by two-tenths of a percentage point to 3.7%.

However, the October JOLTS number released on the 5th of December showed that the vacancies-to-unemployment ratio declined month-on-month to 8.7 million from 9.4 million as employers’ demand for workers seems to have waned.

Despite this, ISM Services PMI data and the University of Michigan’s consumer sentiment index contrast the signals of a weakening labour market. Data released on the 5th of December showed that the ISM Services PMI increased to 52.7 in November, ahead of expectations and prior data, amid a faster increase in business activity and employment. Furthermore, the University of Michigan’s consumer sentiment data of 69.4 for the month of December also beat expectations and the prior figure released driven primarily by the positive effects of the anticipated path of inflation.

Given the data’s mixed signals, the Federal Reserve, at the time of writing, is expected to maintain rates at their current level at its upcoming meeting this week. That is, to keep the Federal Funds Rate at 5.25% - 5.50%. Should the Federal Reserve keep rates unchanged, this would mark the third consecutive meeting whereby the Federal Reserve has decided to do so. While markets have priced in 100bp of rate cuts in 2024, the focus of this week’s meeting will be the updated Summary of Economic Projections with particular attention given to the median participants’ projections for core PCE inflation and the funds rate for 2024.

On the other side of the Atlantic, the European Central Bank (“ECB”) and the Bank of England (“BoE”) are also expected to meet this week and maintain rates at current levels.

The ECB’s meeting is likely to convey a dovish message. Over recent weeks, Executive Board Member Schnabel took markets by surprise as only a month ago Schnabel emphasised the risk of disinflation stalling in the “last mile” and had not ruled out the possibility of further hikes. However, since then, Schnabel seems to have accepted the possibility of a cut before mid-2024 should inflation data remain favourable. The ECB meeting is also likely to result in both growth and inflation projections to be revised lower.

Besides keeping rates unchanged, the BoE is expected to maintain its hawkish stance at this week’s meeting. The hawkish rhetoric is expected due to the high level of inflation in the U.K. despite softer price and wage data together with a weakening labour market. However, while the market is beginning to pencil in a rate cut as early as May 2024, it is unlikely to occur before mid-summer.

As a result, sovereign markets have rallied over recent weeks given the expectations around inflation and monetary policy. In fact, over the past month the yield on the U.S. ten-year has declined by circa four-tenths of a percent to 4.28% while the German ten-year has declined by almost half a percentage point over the same period to 2.26%. Within the corporate bond market, the sentiment around potential rate cuts in 2024 has led to tighter spreads over the past month. In fact, corporate credit spreads have tightened by circa 21 basis points within the European Investment Grade market and by circa 95bp within the European High Yield market.

Going into 2024, the market’s focus is expected to remain on the rate at which inflation is expected to decline together with the timing and magnitude of the first rate cut by any of the three major central banks.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.