Pesky Data

The market’s pricing of the Fed has finally converged towards the FOMC’s dot plot: there are now less than four full 25 bps cuts priced in by the end of 2024. Even if that shift has been developing since the beginning of the year, last week’s trigger was the release of a disappointing core CPI print for January. On a 3-month basis the re-acceleration since a trough in August was confirmed. True, the message from the core PCE – the Fed’s favourite gauge – has diverged lately (no clear re-acceleration trend there ) but some of the CPI resilience will likely find its way to the PCE this time. Indeed, fast-growing rents – which play a smaller role in the PCE – are not the only driver of robust price growth in the services sector. The dataflow needs to change quickly, otherwise there is a risk the market will take its shift further and “overtake the dot plot” to push the start of accommodation to very late, if at all, in 2024.

Meanwhile, the ECB Governing Council is busy discussing publicly which “policy mistake” is the most plausible. Isabel Schnabel and Joachim Nagel took a firm view: the risk of cutting too soon still dominates. We agree that the policy space at the ECB is now ample enough that failing to respond early to the deterioration of the real economy could be offset by deep and quick rate cuts down the line. Yet, we are concerned that the adverse consequences for the Euro area of a delayed monetary policy response could be compounded by the restrictive turn of the fiscal stance. Moreover, having the ECB slashing rates in an emergency mode after a late first cut would not do wonders to the central bank’s credibility. BDF Governor Villeroy de Galhau is clearly preoccupied by the risk of cutting too late. We think his interview to L’Echo last week was implicitly an offer of a quid pro quo to the hawks: an early cut would be “offset” by a slow pace of subsequent loosening, and the final level of the policy rate would not be as low as what was seen between the Great Financial Crisis and Covid. This strengthens our view that there should be a floor to the overall quantum of rate cuts priced by the market this year, now significantly larger than for the Fed.