US Inflation; ECB Cuts Rates; UK GDP Slows
Author: Tom McGrath CIO, 8AM Global
Market Review
By the end of another uneventful week of equity market movements, investors were scratching their heads, wondering if they would get a final end-of-year surge. Perhaps the ‘Trump Bump’ took any wind out of a potential Santa Rally, with equity markets soggy, although Big Tech did pop higher after strong Broadcom results on Thursday. Most of the ‘big action’ came in the bond markets, with yields moving higher on the week as a new narrative takes hold that sees a much more cautious Fed next year. The inflation numbers, which came out in line for CPI but worryingly higher for PPI, probably won’t stop the Fed from cutting next week but might ensure a more hawkish tone in the mood music that accompanies the decision. Elsewhere, UK growth was disappointing; the ECB cut rates, and China said it would do something huge and significant to stimulate growth next year. However, it disappointed by not putting numbers to the rhetoric.
US Inflation (CPI & PPI)
In November, headline and core CPI inflation rates were 2.7% and 3.3% year-over-year, still above the Fed’s 2% inflation target but in line with official expectations and better than the ‘whisper’ numbers, which provided some relief to investors. It’s worth noting that the Fed focuses on PCED inflation, which tends to be lower (for example, October’s PCED headline and core inflation rates were 2.3% and 2.8%). The significant component, rent inflation, remains high but shows signs of cooling. If it were excluded, November’s headline and core CPI were up just 1.6% and 2.2% year-over-year, consistent with the type of inflation moderation the Fed looks for.
If you break inflation into the four key groups: food, energy, core goods, and core services, you can see that the problem is still the stubborn price increases in services, primarily driven by rising wages. Here, we did get some good news; with the increase in wages dropping to 4.3%, according to the Atlanta Fed, we may see service inflation moderating next year, especially if unemployment continues to tick higher. There was enough in the CPI data to understand why the Fed still think rate cuts might be warranted next year.
However, before we get carried away down the Goldilocks path, we got a hotter PPI number as November’s report showed a 0.4% monthly increase and a 3.0% annual rise. This result was the highest annual PPI figure since February 2023, with substantial upward revisions to previous months. For the Federal Reserve, this complicates the outlook. While the PPI is not the Fed’s primary inflation gauge, its influence on the PCED could mean fewer rate cuts next year than expected. Given the move in bond markets, it’s probably safe to say, and somewhat of a relief that investors are now pricing in the possibility of prolonged higher rates.
The current nailed-on consensus is that the Fed will cut the federal funds rate by 25bps on December 18th. But it might be a ‘hawkish cut’ as I suspect that in the FOMC’s Statement and Summary of Economic Projections, we could see signalling of a pause in rate cutting early next year. Powell already sounded less dovish at the last conference when he remarked, ‘the economy is not sending any signals that we need to be in a hurry to lower rates. The strength we are currently seeing in the economy allows us to approach our decisions carefully.
UK
I bet Andrew Bailey at the BoE would love to have the same headache of a strong economy to worry about, as news broke last week that Britain’s economy shrank for the second month in October, with GDP dipping 0.1%, mirroring September’s contraction. Economists had anticipated modest growth, but instead, services stagnated, while manufacturing and construction also saw declines. The pound weakened in response to the news.
Under Prime Minister Keir Starmer’s Labour government, the economy has expanded in just one of the four months since their landslide victory in July. After a strong first half of the year, growth has slowed sharply, with GDP increasing only 0.1% in the third quarter. Labour’s ambitious promises to improve living standards and make the UK the fastest-growing G7 economy are being tested by a cooling job market, rising mortgage and energy costs, and businesses adjusting to a significant payroll tax increase. All of these factors could push prices higher or lead to job cuts. If they could roll back time, they would not have spent the summer talking down the economic outlook and perhaps even delayed the increase in NI contributions for employers till 2025, but hindsight is a wonderful thing.
Consumer-facing services were the biggest drag in October, with output falling 0.6%, including a steep 2% drop in pubs and restaurants. This suggests people put spending on hold as they prepared for the government’s budget, given the bombardment on the news of how bad things were. Although UK consumer confidence remained subdued in December, with households hesitant to make big purchases, there was some slight optimism about personal finances, according to GfK’s sentiment index, which rose one point to -17. I get a sense that retailers face a tough holiday season, and it may be just my imagination, but there seem to be fewer people in the shops this Christmas; perhaps they are going to be spending on holidays instead, given the steady cold grey days we are getting?
Hot air from China
Beijing is signalling more stimulus measures for 2025, including raising its budget deficit and cutting interest rates, according to plans outlined at the Central Economic Work Conference led by President Xi Jinping. The meeting emphasised the need to sustain economic growth, stabilise jobs, and manage prices while pledging to increase the supply of long-term treasury bonds and local government notes to support infrastructure and public spending.
This is terrific news and builds on earlier moves by the Politburo, which shifted to a ‘moderately loose’ monetary stance, which, to be fair, is a significant policy pivot. However, investors (including me) were hoping for numbers and clearer details on measures such as consumption stimulus and strategies for clearing property inventory. But on reflection, with Trump yet to play his hand on tariffs, the Chinese are probably quite sensibly holding back to see just what might be needed.
The growth target has been maintained at 5%, so they must start running a significant budget deficit and cutting rates. We shall see. If we do get those sorts of measures and the Trump moves aren’t too draconian, I wouldn’t bet against the Chinese economy hitting the 5% target next year, and I don’t think it could slump into a Japanese-style deflationary environment as some market commentators have suggested. If things work well, the Chinese Stock Market could be the long-odds winner in 2025.
Europe Cuts
Europe’s central banks are getting a more dovish turn to support their economies amid growing uncertainties, including Donald Trump’s second term and potential global disruptions. On Thursday, the ECB cut its rate by a quarter point, bringing it to the lowest level in a year and a half, and signalled more reductions could follow in early 2024. This marks a shift to a more accommodative stance, as officials prioritise economic stability over inflation concerns; our own BoE may make similar adjustments if growth here continues to slow.
The ECB has also downgraded its growth forecasts, expecting the Eurozone economy to expand just 1.1% in 2025, down from 1.3%. President Christine Lagarde emphasised that risks to the outlook remain tilted to the downside, citing sluggish growth and the potential impact of trade tensions. Other central banks in Europe are following suit. The Swiss National Bank even surprised markets with a half-point rate cut, bringing rates to 0.5%, while Danish policymakers also lowered borrowing costs. And it’s not just in Europe that there are concerns about trade and currency volatility, with Canada cutting its rate by half a point and Brazil raising rates to counter fiscal and currency turmoil.
Investors now anticipate deeper cuts from the ECB, with rates possibly falling to 1.75% by the second half of 2025. Despite these efforts, ECB officials warn that recovery will likely be slow, with no significant rebound expected soon. Lagarde remains optimistic that the new year will clarify global risks, including US trade policies under Trump. For now, Europe’s central banks are firmly focused on navigating these challenges with a more flexible and supportive monetary approach, which will provide a degree of support to the equity markets.
Caveat Emptor
I feel the need to throw in a note of caution at the end of these weekly missives. I remain entirely on the path of the bulls but have short-term gut niggles at the moment, although a few more ‘soggy weeks’ like the last one make me breathe easier so that we aren’t heading into dangerous ‘melt-up’ territory. So, here’s this week’s concern. In December, despite the market going up, on most days, more stocks declined than advanced, whereas in a traditional bull market, it should be broadening out, not narrowing. Almost as soon as investors were willing to write them off, the rally again became reliant on the big tech names that dominate the market cap trackers like Alphabet, Microsoft, and Nvidia.
Strategists (aka the Bears) warn that this narrowing market participation, or poor breadth, could signal cracks in the rally’s foundation. Less than half of S&P 500 stocks are trading above key support levels, and some analysts believe this could be a sign of a coming downturn. I believe this party is over when we get a significant slowdown in growth. I am not saying that it can’t happen next year; I just don’t see any signs of it, and more likely, growth will accelerate coupled with substantial productivity gains.
This Week
All eyes will be on the Fed, which is expected to cut rates by 25 basis points on December 18th, signalling its monetary policy stance for 2025. November retail sales data (December 17th) and existing home sales (December 19th) will provide key insights into US consumer strength and housing. Globally, the Bank of Japan and Bank of England are likely to hold rates steady, while Canada releases its fall economic statement on December 16th.
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