02.02.24

Central Bank Update: February 2024 – Where are the rate cuts?

Our Central Bank Update for Q1 | February 2024 is an incisive summary of recent movements from some of the key central banks globally. Let’s take a closer look at what has been happening so far this year…

Since last Autumn, financial markets have been aggressively pricing significant interest cuts by three of the major central banks – namely, the European Central Bank (ECB), the Bank of England (BoE), and the Federal Reserve Bank (Fed). This adjustment was in response to a notable decline in inflation and a very dovish tone at the Fed’s mid-December 2023 meeting.

 

Source: Bloomberg Finance L.P.

 

Over the past week, all three of these central banks conducted monetary policy meetings, providing us with more insight into their thinking regarding potential interest rate cuts.

Each conveyed a similar message – inflation has declined significantly over the past six months and is approaching their 2% target. Their current monetary policy stance is restrictive and as inflation falls there is a risk their policy becomes too restrictive, hence the possibility of interest rate cuts to offset that unintended additional tightening. None of the central banks are prepared to convincingly assert that inflation has been successfully curbed; they expressed a collective desire for additional economic data before reaching any conclusive decision.

The ECB specifically highlighted wage data, noting that despite minimal growth in the Eurozone throughout 2023, the unemployment rate has reached all-time lows since the launch of the Euro. Recent labour actions illustrate that workers feel they still have bargaining power to press for higher wages. President Lagarde of the ECB expressed a desire to see some moderation in wage gains, emphasising the significance of the upcoming wage data in spring as a crucial factor in their decision-making on interest rates. This suggests that rate cuts by the ECB may commence at their policy meeting in May, providing of course that wage gains meet their expectations.

Chairman Powell of the Federal Reserve was much more explicit stating that rate cuts were unlikely at the upcoming March FOMC meeting. Acknowledging that their preferred measure of inflation had been running at their target rate of 2% for the past six months, Powell admitted that the FOMC remained unconvinced that this was going to continue. Indeed, he emphasised the need for additional inflation data before considering any rate cuts. Their next meeting in March, will feature a new set of forecasts which should provide some insights as to whether May or June will see the first rate cut. Historically, there is an average of 8 months between the last Fed rate hike and the first Fed rate cut, with the last rate hike in July 2023, which makes March 2024 exactly 8 months later.

On February 1st, the Bank of England presented updated forecasts, with Governor Bailey asserting that in light of these new (lower) inflation projections, maintaining interest rates at the current level of 5.25% could result in a policy stance deemed excessively tight.

 

Sources: Bloomberg Finance L.P., ONS and Bank calculations

 

So, cuts are coming. Mirroring the somewhat cautious stance of the Fed, the BoE would like to see additional data before they begin to lower rates. Wage inflation has fallen, but is still too high, and service inflation remains over 6% posing challenges in achieving the BoE’s inflation target of 2%. Once again, May or June seems the earliest time that the BoE would first lower rates.

The potential impact of these interest rate cuts is, by and large, already reflected in market dynamics with fixed income and equities experiencing significant price increases since November 2023. In essence, the markets have pre-emptively factored in the likelihood of rate cuts. Notably, as inflation started to cool, yields on 2-year UK and US government bonds have decreased by approximately 100 basis points, while German two-year government bonds have seen a decline of nearly 90 basis points. The expectation of interest rate cuts has significantly influenced these adjustments.

 

Bond yields fell significantly in Q4 2023

 

While equities had a strong rally

Source: Bloomberg Finance L.P.

 

Unless the central banks do much more than the markets are already pricing (or much less), we do not anticipate market direction being driven by them, a departure from the trend observed over the past two years. In the broader context, whether base rates stand at 4% or 5% this is unlikely to exert a substantial influence on economic activity and corporate earnings. Central bank policy was so important in 2022 and 2023 due to the magnitude of their rates moves – increasing interest rates from zero to 5% is a big deal. However, a shift from 5% down to 4% is not expected to carry the same level of significance and influence.

Concluding, I would like to draw attention to the escalating US government debt. Since the start of the 2024 fiscal year on 1 October 2023, the US government deficit has surged by approximately $509 billion compared to the first three months of fiscal 2023. For the full year, the deficit was 7.5 % of GDP, occurring in a year where economic growth exceeded 3%. Already in this fiscal year, both Medicare and Social Security expenditures have risen by over 12%. Compounding these financial pressures are substantial outlays associated with the Chips Act (supporting the semiconductor sector) and the ironically named Inflation Reduction Act. Given the substantial fiscal stimulus in an economy already operating at full employment, the sustainability of the Fed’s current success in curbing inflation becomes uncertain. This problem is not unique to the United States. Running large fiscal deficits was easy during the zero-interest rate world post the 2008 Global Financial Crisis and large deficits were seen as normal. Governments globally are finding it difficult to reduce spending – the pressure to reduce government expenditure is likely to have repercussions on longer-term interest rates.

 

Explore other interesting insights from the Oakglen investment team on our News & Insights page, such as our recent 2024 Investment Outlook or the piece on the Houthi attacks in the Red Sea. Sign up below to receive similar content directly into your inbox.

Want to become an Oakglen client? Get in touch with one of our wealth team via the Contact Us page to hear more about our products and services, and how suitable they are for you and your personal circumstances.

Jeff Brummette
Chief Investment Officer

Disclaimer

This document is distributed by Oakglen Wealth Limited and / or Oakglen Wealth (Jersey) Limited (hereafter “Oakglen”) to you for your information and discussion only. Unless otherwise stated nothing in this document constitutes investment, legal, accounting, real estate, conveyancing, surveying or tax advice, or a representation that any investment is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you. It is not a solicitation or an offer to buy or sell any security or other financial instrument. Any information including facts, opinions or quotations, may be condensed or summarised and is expressed as of the date of writing. The information may change without notice and Oakglen is under no obligation to ensure that such updates are brought to your attention. The price and value of investments and any income that might accrue could fall or rise or fluctuate. The price of shares and income from them may fall as well as rise and is not guaranteed. You may not get back the amount of your original investment. A change in the economic environment, possible changes in the law and other events may cause future performance to deviate from that expressed or implied in this document. Please note that past performance, simulations and forecasts are not a reliable guide to future returns. If an investment is denominated in a currency other than your base currency, changes in the rate of exchange may have an adverse effect on value, price or income. Investing in Packaged Retail and Insurance-based Investment Products (PRIIPs) carries a high level of risk and may not be suitable for all investors.

Any information provided by a client and used to produce this document will have been checked by Oakglen for plausibility only and the client notified accordingly of any obvious anomalies. This document and any related recommendations or strategies may not be suitable for you; you should ensure that you fully understand the potential risks and rewards and independently determine that it is suitable for you given your objectives, experience, financial resources and any other relevant circumstances. You should consult with such adviser(s) as you consider necessary to assist you in making these determinations. The opportunities and risks associated with each investment product can be found in the relevant underlying securities prospectus and any other supplementary documents. All documents will be made available at any time upon request.

Oakglen does not advise on the tax consequences of investments, and you are advised to contact a tax adviser should you have any questions in this regard. The levels and basis of taxation are dependent on individual circumstances and are subject to change. This document may relate to investments or services of an entity/person outside the United Kingdom, or to other matters which are not regulated by the Financial Conduct Authority, or in respect of which the protections of the Financial Services Compensation Scheme. Further details as to where this may be the case are available on request in respect of this document. Additionally, this document may relate to investments or services of an entity/person outside Jersey, or to other matters which are not regulated by the Jersey Financial Services Commission, or in respect of which the protections of the Jersey Financial Services Commission for retail clients. Further details as to where this may be the case are available on request in respect of this document.

This document has been prepared from sources Oakglen believes to be reliable, but we do not guarantee its accuracy or completeness and do not accept liability for any loss arising from its use. Oakglen reserves the right to remedy any errors that may be present in this document. Oakglen, its affiliates and / or their employees may have a position or holding, or other material interest or effect transactions in any securities mentioned or options thereon, or other investments related thereto and from time to time may add to or dispose of such investments.

This document is intended only for the person to whom it is issued by Oakglen. It may not be reproduced either in whole, or in part, without our written permission. The distribution of this document and the offer and sale of the investment in certain jurisdictions may be forbidden or restricted by law or regulation. This communication does not constitute the solicitation of an offer to purchase or subscribe for any investment or service in any jurisdiction where, or from any person in respect of whom, such a solicitation of an offer is unlawful.

Investments may have no public market or only a restricted secondary market. Where a secondary market exists, it is not possible to predict the price at which investments will trade in the market or whether such market will be liquid or illiquid. As such, for investments not listed or traded on any exchange, pricing information may be more difficult to obtain, and the liquidity of the investments may be adversely affected. A holder may be able to realise value prior to an investment’s maturity date only at a price in an available secondary market. The issuer of the investment may have entered into contracts with third parties to create the indicated returns and/or any applicable capital protection (in part or in full). The investment instrument's retention of value is dependent not only on the development of the value of the underlying asset, but also on the creditworthiness of the Issuer and / or Guarantor (as applicable), which may change over the term of the investment instrument. In the event of default by the issuer and/or Guarantor of the investment, and / or any third party the investment any income derived from such contracts is not guaranteed and you may get back none of, or less than, what was originally invested. Parties other than the Issuer or Guarantor (as appropriate) mentioned in this document (for instance the Lead Manager, Co-structurer, Calculation Agent or Paying Agent) do neither guarantee, repayment of the invested capital nor financial return on the investment product, if nothing is indicated to the contrary. Any capital protection given is usually an inherent part of the product; provided through the use of options, futures or other derivative products. You may have to accept smaller returns on an investment relative to a direct investment in the underlying index, basket, etc. because of the costs involved in providing the capital protection. Such capital protection normally only applies if the investment is held until maturity. The amount of initial capital to be repaid may be geared, which means that a fall in the underlying index or securities may result in a larger reduction in the amount repaid to investors. Alternative investments, derivatives or structured products are complex instruments that typically involve a high degree of risk and are intended for sale only to investors who are capable of understanding and assuming the risks involved. Structured products carry counterparty risk, in that in the event of default by the issuer you may lose some or all of your capital invested even when the product carries capital guarantees. Where this document relates to emerging markets, such investments should be made only by sophisticated investors or experienced professionals, who have independent knowledge of the relevant markets, are able to consider and weigh the various risks presented by such investments and have the financial resources necessary to bear the substantial risk of loss of investment in such investments.

The services described are provided by Oakglen or by its subsidiaries and/or affiliates in accordance with appropriate local legislation and regulation. Certain products and services may not be available in all locations or to all Oakglen clients.

Data Source: Oakglen Wealth (Jersey) Limited and Oakglen Wealth Limited, otherwise specified.

Oakglen is a registered business name of Oakglen Wealth (Jersey) Limited and Oakglen Wealth Limited.

Oakglen Wealth (Jersey) Limited is regulated in Jersey by the Jersey Financial Services Commission for the conduct of Investment Business and is a limited company with company number 121454, incorporated in Jersey on 7 June 2016. Its business address is 4th Floor, 1 IFC, St Helier, Jersey, JE2 3BX.

Oakglen Wealth Limited is authorised and regulated by the Financial Conduct Authority. The registered address of Oakglen Wealth Limited is 30 Golden Square, London, United Kingdom, W1F 9LD and is registered in England and Wales with number 13182724.