The Fed and Bank of England: Markets still disregarding the signs?

Federal Reserve

The Federal Reserve (Fed) decision on Wednesday night (31 January) turned out to be a bit of a non-event from a market perspective, maintaining the target range at 5.25% to 5.50%.

Prior to the meeting, the market was expecting that the Fed would cut rates six times through 2024, with a possibility that they could begin as soon as March. However, the main information to be gleaned from the press conference was that the members of the committee saw no need to rush into rate cuts. They expect that interest rate cuts are on the cards, but they intend to wait for a while longer. Fed Chair, Jerome Powell, stated specifically that “I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting to identify March as the time to cut”. With regards to the tapering of quantitative tightening, he also showed a lack of urgency by stating that this “would not be discussed until March”. So, in summary, keep calm and carry on. As a result, the markets just pushed out the timing of the rate cuts but did not translate Powell’s rhetoric into less cuts.

Our view is that interest rate cuts will come in the second half of 2024, but much slower than the market expects. US data remains very upbeat with strong productivity, robust wages and a tight labour market which is now benefitting from an increase in real wages as headline inflation falls.

What’s the rush to cut rates?

I think we can comfortably say that the Fed are more in our camp and would prefer to see more evidence that inflation is heading sustainably back towards the 2.0% target. However, this go-slow approach is not without its risks. Risk markets are expecting Powell to slash rates sooner before there’s a recession and deliver the much fabled ‘soft-landing’, but the longer the Fed wait, the likelihood of a harder landing increases. By contrast, easing too early could result in a further inflationary pulse. This is a very difficult tightrope to walk and at the moment it seems the Fed would rather sit tight and discuss traversing that tightrope in the future, whilst risking the safety net below them could be withdrawn.  

Bank of England

At yesterday’s meeting the Bank of England (BoE) decided to maintain interest rates at 5.25%. As has been the case for some time, the committee was somewhat split in its voting intentions; two members voted for a hike, six members voted to leave rates unchanged, and for the first time in this phase of the rate cycle, one member called for a cut in the bank rate to 5.0%. With inflation having fallen from the lofty summer highs of 2023, and the 2.0% Consumer Price Index target in sight, it is no surprise that the committee is turning more dovish. Rates have peaked; that has been evident for some time, regardless of the Bank's recent communication and bias about upside risks to inflation and interest rates. After yesterday’s meeting there should be little doubt that the next move in rates will be lower.

But none of this is really new news. The market has long disregarded the nuances within the BoE’s communication. Bond markets have for some time been pricing in interest rate cuts, and at one point in late December 2023, were pricing the first cut as early as March 2024. That felt far too early, certainly on the evidence of recent economic data. Labour markets, although loosening, remain tight; far too tight for a central bank to be in a rush to lower rates. In the UK, core inflation still remains uncomfortably high. And it is the stickiness of core inflation, as well as the upcoming round of wage negotiations, that is keeping the BoE firmly on hold. Inflation is expected to hit the 2.0% target in the second quarter before rising again over the summer months. The BoE will need confidence that inflation is sustainably close to the 2.0% target over the medium term before it loosens its monetary policy by cutting rates. Given the current state of the economy and the history of interest rate cutting cycles lasting around nine months on average, current market pricing is implying a path that starts with a cut in June 2024 and settles at 3.25% in March 2026, which seems somewhat drawn-out.

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