The new year has started on a sour note for the global markets, as investors brace for a possible slowdown in economic growth and corporate earnings. The main reason behind the pessimism is the expectation that central banks around the world will cut interest rates in 2024, in response to rising inflation and weakening demand.
Interest rate cuts are usually seen as a positive stimulus for the markets, as they lower the cost of borrowing and encourage spending and investment. However, in the current scenario, rate cuts may also signal that the economy is in trouble, and that the central banks are running out of options to boost growth.
One of the main drivers of the rate cut expectations is the Federal Reserve, the US central bank, which has been hinting at a more dovish stance in its recent statements and projections. The Fed has raised its key interest rate 15 times since the end of 2021, from 0.1% to 6.25%, in an attempt to keep inflation under control and normalize its monetary policy after years of ultra-low rates.
However, the Fed’s tightening cycle has also contributed to slowing down the US economy, which grew by only 1.9% in the third quarter of 2023, the lowest rate since 2019. The Fed has also faced criticism from President Donald Trump, who has repeatedly accused the central bank of being too aggressive and hurting the US economy and stock market.
The Fed has acknowledged the risks and challenges facing the economy, and has indicated that it may pause or reverse its rate hikes in 2024, depending on the data and the outlook. The markets are pricing in a 89% chance of a rate cut in March 2024, and as much as 158 basis points of easing by the end of the year, according to the CME FedWatch tool.
The Fed is not alone in its dovish turn, as other major central banks are also expected to cut rates in 2024, amid rising inflation and slowing growth. The European Central Bank (ECB), which has kept its key interest rate at -0.5% since 2019, is facing pressure to ease its policy further, as the euro zone economy struggles with the impact of the Brexit, the trade war, and the social unrest. The ECB is projected to cut its rate by 165 basis points in 2024, according to the Bloomberg Eurozone Overnight Index Swap Curve.
The Bank of England (BoE), which has raised its key interest rate four times since 2017, to 1.75%, is also facing a dilemma, as the UK economy grapples with the uncertainty and the fallout of the Brexit. The BoE has warned that the Brexit could have a significant negative effect on the economy, and has said that it could cut or raise rates depending on the outcome of the negotiations. The markets are pricing in a 50% chance of a rate cut in May 2024, and a 100% chance of a cut by the end of the year, according to the Bloomberg Sterling Overnight Index Swap Curve.
The Bank of Japan (BoJ), which has kept its key interest rate at -0.1% since 2016, and has pursued an aggressive quantitative easing program, is also facing challenges, as the Japanese economy suffers from low growth, low inflation, and low consumer confidence. The BoJ has been reluctant to cut its rate further, fearing the negative impact on the banking sector and the financial stability. However, the BoJ has also said that it will not hesitate to take additional easing measures if necessary, and has hinted at a possible rate cut in 2024, if the inflation outlook worsens.
The rate cut expectations have had a mixed effect on the markets, as they reflect both the hopes and the fears of the investors. On the one hand, rate cuts could provide some relief and support for the markets, as they could boost liquidity, lower borrowing costs, and stimulate demand. On the other hand, rate cuts could also indicate that the economy is in a worse shape than expected, and that the central banks are running out of ammunition to fight the slowdown.
The markets have reacted negatively to the rate cut expectations, as they have focused more on the downside risks than on the upside potential. The global stock markets have fallen sharply in the first week of the new year, as investors have sold off their risky assets and moved to safer havens. The MSCI World Index, which tracks the performance of the equity markets in 23 developed countries, has dropped by 3.2% since the start of the year, as of January 7, 2024. The S&P 500 Index, which represents the US stock market, has fallen by 4.1% in the same period.
The bond markets have also reflected the rate cut expectations, as the yields on the government bonds have declined, reflecting the lower interest rates and the lower inflation expectations. The yield on the 10-year US Treasury bond, which is a benchmark for the global bond market, has fallen by 0.2 percentage points since the start of the year, to 2.8%, as of January 7, 2024. The yield on the 10-year German bund, which is a proxy for the euro zone bond market, has fallen by 0.1 percentage points, to -0.3%. The yield on the 10-year UK gilt, which represents the UK bond market, has fallen by 0.2 percentage points, to 1.2%.
The currency markets have also been affected by the rate cut expectations, as the exchange rates have moved in line with the interest rate differentials and the economic outlook. The US dollar, which is the world’s reserve currency and the most widely used in international trade and finance, has weakened against most of its major peers, as the rate cut expectations have reduced its appeal and its yield advantage. The dollar index, which measures the value of the dollar against a basket of six other currencies, has fallen by 1.2% since the start of the year, to 99.6, as of January 7, 2024. The dollar has lost 1.4% against the euro, 1.6% against the pound, and 1.8% against the yen in the same period.
The rate cut expectations have also had an impact on the commodity markets, as they have influenced the demand and the supply of the raw materials. The oil market, which is one of the most important and volatile commodity markets, has been under pressure, as the rate cut expectations have raised concerns about the global economic growth and the oil demand. The price of Brent crude, which is the international benchmark for oil, has fallen by 6.4% since the start of the year, to $54.2 per barrel, as of January 7, 2024. The price of West Texas Intermediate (WTI) crude, which is the US benchmark for oil, has fallen by 7.2%, to $49.8 per barrel.
The gold market, which is considered as a safe haven and a hedge against inflation and currency devaluation, has benefited from the rate cut expectations, as they have increased the demand and the attractiveness of the precious metal. The price of gold, which is quoted in US dollars, has risen by 4.2% since the start of the year, to $1,582.6 per ounce, as of January 7, 2024.
The rate cut expectations have thus created a complex and uncertain environment for the markets, as they have mixed implications and consequences for the economy and the financial system. The markets are likely to remain volatile and sensitive to the data and the news, as they try to anticipate and adjust to the policy actions and the economic developments. The investors will have to be cautious and flexible, as they navigate the challenges and the opportunities of the new year.
