A major Wall Street bank is considering what it calls an “extreme scenario” in which none of the G10 central banks cut interest rates this year due to flat inflation, strong economic growth or new shocks that push price gains higher.
In a note on Tuesday, Athanasios Vamfakidis, a UK-based FX strategist at Bank of America BAC,
He said it was worth considering the implications of an “unrealistic” scenario in which major central banks appear to be in a holding pattern.
Currently, markets are pricing in about six interest rate cuts by the Federal Reserve and the European Central Bank, starting in March and April, respectively; Five cuts by the Bank of England; And two cuts by the Reserve Bank of Australia. B. of A. expects lower cuts for all of these cuts due to persistent inflation, resilient economies and “stretched” labor markets, the strategist said.
What added some credibility to B's views of A were comments from policymakers in the United States and abroad. ECB Governing Council members Robert Holzmann and François Villeroy de Galhau tried to calm market hopes for an interest rate cut on Monday and Tuesday. Fed Governor Christopher Waller also said there was no need to “rush” interest rate cuts. Their comments helped prompt a sell-off in the US bond market that pushed the 10-year bond yield BX:TMUBMUSD10Y up 11.5 basis points to 4.064%, and prompted fund traders to pull back slightly on the extent of interest rate cuts they envision by December.
“The most important market discussion as the new year begins is not whether G10 central banks will start cutting interest rates, but when and how quickly they will start,” Vamvakdis said. “Even if the scenario of central banks remaining unchanged this year may seem completely unrealistic to the consensus, it is still worth considering its implications for the market from our perspective, as we are puzzled by the market's aggressive pricing of interest rate cuts this year.”
In B. of A.'s discussions with investors for next year, “no one has considered a scenario in which no central bank cuts rates this year,” the strategist wrote in a note Tuesday titled “Contemplating the Unthinkable.” He said an “extreme scenario in which G10 central banks do not cut interest rates this year” would likely be positive for the dollar, euro and Swiss franc against the Norwegian krone, Australian dollar and Japanese yen.
Adding to concerns about persistent inflation are two factors at the moment. One is developments in the Middle East, where US-led strikes on Houthi rebels in Yemen have led to the targeting of British oil company Shell PLC SHEL,
Suspension of shipments through the Red Sea. As traders continued to monitor events, oil futures CL00 rose,
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It initially rose before ending lower on Tuesday.
The second factor is wage growth in the United States, which came in at an unexpectedly strong 0.4% for the month of December and 4.1% on an annual basis, as described by Brent Schott, chief investment officer at Northwestern Mutual Wealth Management based in Milwaukee. “, as “the only remaining ember that could reignite inflation.”
Treasury yields finished with their biggest one-day jump in a month or two on Tuesday. This was the case even though traders in federal funds futures mostly clung to expectations of the Fed cutting interest rates by at least a quarter of a percentage point by December, which would push the key US interest rate target to 4% or 3.75% or less. US stocks DJIA SPX COMP closed lower, while the ICE US Dollar Index DXY rose 1%.
The kind of cuts in US interest rates that markets are currently envisioning are maintenance moves, designed to prevent interest rate levels from becoming too restrictive as inflation declines.
