Weekly Focus – Hawkish Christmas Present from US Federal Reserve

The tradition of central banks hosting meetings just before Christmas continued this year with policy decisions in the US, Japan, UK, Norway, and Sweden. The largest present came from the US Federal Reserve in the shape of a significant hawkish surprise. Fed cut the policy rate target by 25bp to 4.25-4.50% as expected, but Powell delivered a clearly hawkish message, highlighting that the easing cycle has entered a “new phase” in which the Fed is looking to slow down the pace of rate cuts. The updated “dots” now project only two 25bp cuts next year compared to four in the September projections. The main reason for the hawkish turn was an upward revision of the inflation forecast to 2.5% y/y in 2025 (from 2.1%) and the fact that most members even saw upside risks to the new inflation projections. The decision pushed the entire UST curve up by some 13-15bp, and the market is now pricing only 40bp worth of cuts from the Fed next year. Due to the change in guidance, we have removed our expectations for a cut in January but continue to expect four cuts next year from March.

Both the Bank of Japan and Bank of England left their policy rates unchanged at 0.25% and 4.75%, respectively, as broadly expected. As the economic recovery looks on track, we expect the BoJ to hike the policy rate in January. The BoE delivered a dovish vote split but continue to signal a gradual cutting approach. We expect the next cut in February and a quarter pace thereafter. For Sweden and Norway, see page 4.

On the data front, the December PMI surveys gave some relief for the growth outlook as services PMIs rose more than expected in both the US, euro area, and UK. Services PMIs bounced back above 50 in the euro area following the large decline in November in a sign that activity is holding up while the US services PMI rose even further to 58.5 from 56.1. In contrast to the services sector, activity in the manufacturing sector weakened with US manufacturing PMI declining to 48.3, the UK to 47.3, and the euro area remained unchanged at 45.2.

On the political front, the risk of a government shutdown in the US increased this week as president-elect Donald Trump told republican congressmen to not support a stopgap funding bill that was otherwise set to pass Congress. With no other plan ready, the government is again facing a risk of a shutdown, less serious for the economy than in 2018, but still an unpleasant Christmas present for public workers.

In the coming weeks focus will be on the US jobs market report and ISM survey, euro area inflation, and Chinese PMIs and PBoC rate decision. We expect US nonfarm payrolls growth to slow down to +170k (from +227k), a steady unemployment rate at 4.2%, and average hourly earnings growth at +0.3% m/m SA. We expect euro area HICP inflation to rise to 2.4% y/y in December from 2.2% in November. The increase is mainly due to base effects on energy and food inflation while we expect core inflation to decline from 2.7% y/y in November to 2.6% y/y. In China, we expect the PMIs to be unchanged in December following increases in the past two months. Manufacturing activity is currently underpinned by some front loading of exports to the US in anticipation of tariffs next year. The PBOC will also announce its policy rate, which is expected to be left unchanged.

Full report in PDF.