A rosy view

Market recap

• In the current global macroeconomic landscape, the economic trajectories of the United States, Euro Area, and United Kingdom show a synchronized shift towards cautious optimism and resilience amidst challenges.
• Despite high interest rates aimed at tempering economic activity in the United States, the economy remains resilient, reflecting a global trend where central banks, including the Federal Reserve, are carefully navigating between growth and inflation control. Similarly, the Euro Area has emerged from the brink of recession, buoyed by slight improvements in real incomes and credit availability.
• The European Central Bank is maintaining stable interest rates while signaling potential easing in the near future. This cautious optimism is also evident in the United Kingdom where, despite consecutive quarters of contraction, there are signs of a nascent recovery driven by modest growth in the services sector, amidst controlled inflation and a stable job market.

Q1 highlights

• These regional economic snapshots underscore a global economic environment marked by deliberate monetary policies aimed at achieving a delicate balance between fostering growth and mitigating inflation, reflecting a shared trajectory towards gradual recovery and stability across major economies.
• The global economic outlook appears to be mixed but cautiously optimistic. The United States economy is showing robustness despite high-interest rates, indicating a measured approach towards adjusting monetary policy. The Eurozone is emerging from the threat of recession and is on a path to modest recovery, supported by steady interest rates and easing inflation.
• The UK is facing the possibility of a short-lived recession, but it is still managing to maintain manageable inflation rates and a stable job market, suggesting resilience amidst challenges. These insights suggest that there is cautious optimism, with central banks playing a pivotal role in guiding their economies towards sustained growth and stability.

The Eurozone has displayed early indications of recovery after narrowly avoiding a recession in 2023. With increased real income and better availability of credit, the economy showed slight growth in Q1, 2024.

In March 2024, the consumer price inflation rate in the Euro area fell to 2.4% compared to the same month last year, hitting the same low as November's and did not meet the expected 2.6%, according to a preliminary estimate. The core inflation rate, which does not include unpredictable food and energy prices, also decreased to 2.9%, marking its lowest since February 2022 and falling below the anticipated 3.0%. On a monthly basis, consumer prices rose by 0.8% in March, a slight increase from February's 0.6%.

Euro area growth remained stable in Q4 2023, preventing a technical recession.

The Eurozone Composite PMI has been revised upward to 50.3 for March, which is the highest level in ten months. This is a significant increase from February's 49.2 and also from the preliminary estimate of 49.9. It indicates that the private sector in the Eurozone has experienced growth for the first time since last May. However, the surge in business activity has been moderate, and the manufacturing output has continued to shrink, registering at 46.1, which is marginally lower than February's 46.5.

In March 2024, the ECB maintained its current monetary policy stance, keeping the key interest rates unchanged. The rates for main refinancing operations, marginal lending facility, and deposit facility remained at 4.50%, 4.75%, and 4.00% respectively. ECB President Christine Lagarde suggested that an initial rate cut could come in June.

During the same period, the European yield experienced mixed movements. The 3-month Euro short-term rate (ESTER) decreased, while the 6-month and 12-month ESTER rates rose compared to the previous quarter. As of March, the rates stood at 3.87%, 3.68%, and 3.21% respectively. This marked a fall of 1.9 basis points (bps) for the 3-month rate and increases of 9.2 and 18.3 bps for the 6-month and 12-month rates.

The UK's economy shrank in Q4, 2023, marking the second consecutive quarter of contraction.

In February 2024, the inflation rate in the United Kingdom dropped to 3.4% compared to the previous year, a decrease from the 4% observed in January and December. This was below the expected market forecast of 3.5% and marked the lowest inflation rate since September 2021. The decline was attributed to a slowdown in the rise of prices.

UK's PMI for March 2024 was revised upwards to 50.3, indicating the first growth in manufacturing activity since July 2022. Meanwhile, the UK Services PMI for March 2024 dipped to 53.1, representing the most modest growth in four months, but the sector still experienced a relatively strong rate of expansion, with new business continuing to grow.

In Q4, 2023, the UK's economy contracted by 0.3%, marking its entry into a technical recession for the first time since the COVID-19 pandemic's initial impact in early 2020. This downturn was driven by high inflation, unprecedented borrowing costs, and diminished demand from abroad, all of which exerted pressure on consumer demand and business activity.

During its March meeting, the Bank of England decided to maintain the policy rate at 5.25%, which was in line with market expectations. However, the voting pattern significantly shifted, with eight members voting to keep the status quo, and only one member pushing for a rate hike. This is a notable contrast from the previous meeting where three members were divided, and two were in favour of an increase. For the first time in two and a half years, no member voted for a rate hike, indicating a more dovish stance by the committee.

At the end of March, the Sterling Overnight Index Average (SONIA) market adjusted its expectations to a forecast of an initial rate cut in August by 33 basis points. The market also predicted a total decrease of 75 basis points by the end of the year. During its March meeting, the Bank of England chose to maintain its policy rate at 5.25%, which was what the market anticipated. However, the voting pattern changed significantly, with eight members voting to keep things as they were, and only one member pushing for a rate hike. This was a significant difference from the previous meeting, where three members were divided, and two were in favour of an increase. For the first time in two and a half years, no members voted for a rate hike, indicating a more cautious stance by the committee.

By the end of March, the SONIA market had adjusted its expectations to predict an initial rate cut of 33 bps in August. The market also believed that there would be a total fall of 75 bps by the end of the year.

The focus has shifted in the US market as the Fed has reached terminal rates and investors await a potential easing.

Information contained in the Federal Open Market Committee’s (FOMC or the Committee) Summary of Economic Projections released at the March meeting reflected a potential paring back of policy restraint this year despite a more sanguine outlook for economic growth and employment and a modest uptick in projected core inflation.

Based on this information, we expect the FOMC will eventually move to adjust the federal funds rate lower in a gradual fashion should core inflation continue to moderate.

Net T-bill issuance should abate following heavy supply over the past few quarters, while expectations around the timing and extent of any rate cuts by the Fed will, in our view, influence the level of utilization of the New York Federal Reserve’s overnight repurchase agreement program (RRP).

The FOMC maintained the range for the federal funds target rate at 5.25% to 5.50% during the first quarter as it continued in our view to cautiously assess the effects of its policy firming to date.

In a statement¹ released in conjunction with the March meeting, the Committee noted that inflation “remains elevated” while acknowledging that it has “eased over the past year.” The statement also recognized the “solid pace” of economic growth.

The March meeting statement also highlighted that the FOMC views “risks to achieving its employment and inflation goals” as becoming more balanced.

Further, the statement in March acknowledged that the FOMC “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward” its 2% target.

The median federal funds rate forecast contained in the Summary of Economic Projections (SEP)² released in conjunction with the FOMC meeting for 2024 was unchanged from the December 2023 projection of 4.60% and continues to imply, in our estimation, three cuts of 0.25% in the range for the target rate for this year.

The updated SEP for 2024 reflected a higher economic growth projection, a modestly higher core inflation projection and a slightly lower unemployment rate forecast, relative to the December projections. Core inflation is still not projected to fall to the FOMC’s 2% objective until 2026.

The FOMC noted at the March meeting that it will continue reducing its holdings of Treasury securities, agency debt and agency mortgage-backed securities as delineated in its Plans for Reducing the Size of the Federal Reserve’s Balance Sheet released in conjunction with the 4 May 2022 meeting.³ Fed Chair Jerome Powell also noted at the post-meeting press conference that balance sheet runoff could begin “fairly soon.”