Sunset Market Commentary

Markets

Bank of England governor Bailey, ECB president Lagarde and Fed chair Powell today all grab(bed) their final occasion to guide market expectations going into final policy meetings of the year, which for the ECB and the Fed include updated growth and inflation forecasts. BoE Bailey spoke at the Financial Times’ Global Boardroom conference. Headlines suggested that he expects four UK rate cuts next year as inflation eases. In a detailed reading, we think this guidance is more nuanced with Bailey referring to market expectations in the November economic forecast: “We always condition what we publish in terms of the projection on market rates, and so as you rightly say, that was effectively the view the market had.” At that November meeting, the BoE worked with three scenario’s. Apart from the central one, they used one with a faster disinflationary process and one with a less encouraging inflation outlook. Bailey did acknowledge that even in the central view, the BoE would have to lean in a bit harder to keep inflation on a sustainable path towards the 2% target. UK assets initially reacted on the “misleading” headlines, pushing UK yields and GBP lower. The move didn’t last and even rapidly ran on a counter. UK gilts slightly underperform US Treasuries and German Bunds. UK yields currently add around 5 bps across the curve with UK money markets discounting a rate cut skip at the December meeting and a 25 bps rate cut in February. EUR/GBP is again exploring the recent lows near 0.8275 with geopolitics adding a tad of euro weakness after the crew of a Russian ship in the Baltic Sea shot signal ammunition at a German military helicopter.

ECB president Lagarde appeared before a Committee on Economic and Monetary Affairs at the European Parliament. She sounded worried on the short term economic outlook, but expects the recovery to gather some steam further on. Inflation is temporary higher in Q4 but should hit the 2% target in the course of next year. While the target is in sight, it hasn’t been fully reached she added. She didn’t comment on the outcome of the December meeting, but she definitely didn’t push to speed up the policy normalization. We stick to the view that 25 bps rate cuts remain the way forward, in contrasts to EMU money markets discounting at least one 50 bps rate cut at one of the next three ECB meetings. In a broader context, Lagarde endorses ECB chief economist Lane’s recent proposal to base decision making again with a forward looking view rather than sticking with the backward looking data dependency which prompted the surprise October rate cut. Finally, Lagarde confirmed that it’s premature to start discussing the optimal size of the balance sheet, implying that the current run-off could easily continue for at least another 12 months.

Fed Chair Powell only addresses media after today’s European close. Our base scenario is a 25 bps rate cut in December with a potential pause in January on the back of better eco data and awaiting Trump’s agenda. In the meantime, EUR/USD continues drifting south and back below 1.05. November ADP employment growth was near consensus at 146k, but came with a significant downward revision of the October number, from 233k to 184k. The US non-manufacturing ISM is also still scheduled for release in between finishing this report and Powell’s speech.

News & Views

The OECD expects the global economy to grow at 3.3% next year. That’s slightly faster than the 3.2% projected for this year, which was also penciled in for 2025 in earlier estimates. The upgrade came on the account of the US, which the Paris-based organization anticipates to expand a lofty 2.4% vs 1.6% in May. OECD’s Pereira warned, however, that these forecasts assume no change in trade policies, adding that risks to the outlook are increasing from trade tensions and protectionism. French and German growth was cut to 0.9% and 0.7% respectively as political uncertainty lingers and fiscal pressure mounts while the EMU’s figure was lowered to 1.3%. Widening budget deficits are among the key worries for the OECD. It expects that all but the most indebted members of the G7 (Italy and Japan) will continue to increase borrowing as a percentage of GDP. For the OECD as whole, debt to GDP would rise to 117% by end 2026%. Pereira urges governments to “seize this opportune moment” to fix public finances. It warned the UK on the matter, saying that its fiscal stance is unsustainable without additional tax increases. Its large government deficits will keep pushing up debt to 106.2% of GDP in 2026. UK growth is forecasted to come in at 1.7%, up from a previous 1.2% estimate. The institution cautioned central banks to go tread carefully with rate cuts, citing persistent services inflation. The ECB rate should bottom around 2% end 2025 & the Fed’s around 3.25-3.5% in early 2026.