On Tuesday, as traders awaited the results of the Fed's last policy meeting of the year, the US dollar index remained high and fluctuated. As of now, the US dollar is quoted at 106.88.
The US retail sales rate in November was 0.7%, the highest since September, and the market expected an increase of 0.5%.
It is reported that the US Congress has reached an agreement on providing funds to the government before March next year.
The European Central Bank slightly raised the bank's capital requirement from 11.2% to 11.3% on the grounds of increased risks.
Germany's December IFO business climate index was 84.7, the lowest since May 2020.
German conservative chancellor candidate Merz proposed a plan to cut immigration and social spending by 100 billion euros.
The Japanese parliament passed a supplementary budget of 90 billion US dollars to inject funds for economic stimulus.
Geopolitics:
Sources said that the Israeli-Palestinian ceasefire negotiations have entered the "almost final" stage. Hamas said a ceasefire agreement could be reached if Israel did not set new conditions.
Russian Defense Forces Commander Lieutenant General Kirillov was killed in the Moscow bombing. Ukraine claimed responsibility and Russia vowed to retaliate.
Institutional Views Summary
Gregor MA Hirt, Global Chief Investment Officer and Multi-Asset Strategist at Allianz Investments: The Bank of Japan is expected to remain on hold this month or prepare for a rate hike in January
The Bank of Japan is expected to be ready to keep interest rates unchanged in December and may give some guidance on the next move, but will not commit to future actions. He said that economic developments are consistent with the Bank of Japan's outlook, with stable economic growth and inflation data that seem encouraging. While the situation may support a rate hike, Hirt pointed out that news reports indicate that there are concerns within the central bank about acting too early. The reports also indicate that the Bank of Japan sees no negative impact in delaying a rate hike. He added: "We believe that the Bank of Japan may avoid such a move before the holidays, especially given the market volatility in July." The press conference after the interest rate decision will be key to observing clues to confidence in the Bank of Japan's outlook.
Credit Agricole: The Fed will cut rates hawkishly, giving open-ended but… guidance
Interest rate expectations: Credit Agricole expects a 25bps rate cut at the December FOMC meeting, the third consecutive rate cut, and a cumulative rate cut of 100bps for the whole year.
Forward guidance: The Fed may give open-ended forward guidance, emphasizing a data-dependent approach. Powell may hint that a pause in rate hikes may be in early 2025.
Economic context: November employment and inflation data suggest that the Fed may continue to cut rates. Persistent inflation risks portend a slower easing cycle ahead.
Dot plot outlook: The median forecast for the federal funds rate in 2025 and 2026 may be raised to 3.6% and 3.1%, respectively (3.4% and 2.9% in September); suggesting a 75bps rate cut in 2025 and a 50bps rate cut in 2026, which is a reduction from the September rate cut expectations.
Conclusion: The Fed will cut interest rates by 25 basis points, while also sending hawkish signals. Forward guidance may highlight a cautious stance. The Fed may hint at a slower and more cautious easing path in 2025 amid resilient economic conditions and high inflation.
We expect the Fed to decide to cut interest rates by another 25 basis points at this week's Federal Open Market Committee (FOMC) meeting. But the decision may not be unanimous, and Fed Governor Bowman may be more inclined to support a pause in interest rate cuts. The policy statement may hint at a slower pace of interest rate cuts in 2025. We expect three 25 basis point rate cuts in 2025, the dot plot may be more cautious than in September, and the median forecast may be revised up. The latest inflation data showed that the decline in inflation has stalled, with the core PCE annual rate remaining at 2.7%, well above the Fed's 2% target, partly due to the slow decline in housing inflation and one-off factors such as hurricanes that put upward pressure on financial and transportation service prices. Nevertheless, with positive trends in labor productivity (2.2% annual rate in the third quarter), slowing wage growth, consumers' increased sensitivity to price increases, and stable inflation expectations, we expect inflation to continue to decline. But this is only an expectation, not a reality, so the Fed may need to be more cautious in future policy adjustments. On the other hand, employment data show that the labor market is cooling, with a narrow range of industry hiring, and only industries such as government, health care, and education contributing to job growth, and the overall job market is weaker than in 2019. Part of the recent rise in the unemployment rate is due to the increase in new labor market participants, who are counted as unemployed until they find a job. Job vacancies cannot fully absorb this part of the new population, and the unemployment rate is expected to continue to rise slightly. The cooling of the labor market suggests that the federal funds rate should continue to maintain a downward trend.
In addition, the Bureau of Economic Analysis made a significant upward revision to GDP data in September, coupled with consumer spending that exceeded expectations significantly, which may lead the Fed to raise its GDP growth forecasts for 2024 and 2025 in its latest economic forecasts. We believe that the forecast for inflation levels may also be raised as service industry inflation is more sticky than expected. Stronger growth forecasts and stubborn inflation will lead to a shorter duration of the Fed's easing cycle, which will be reflected in the latest dot plot.
In summary, we believe that Fed Chairman Powell will reiterate at the press conference that the Fed will maintain a more cautious attitude, especially with Trump's possible return to the White House, and the impact of his policies on economic growth and prices will bring significant uncertainty.
Since the September FOMC meeting, market expectations for the Fed's actual terminal policy rate have increased by about 60 basis points. The actual 1-year forward OIS rate is stable at 1.7% to 1.85%, 0.8% to 0.9% higher than the median actual long-term rate in September.
Interest rate decision: We believe that the Fed's another 25 basis point rate cut at this week's meeting is almost certain, so the market's focus should be on the difference between the FOMC's terminal interest rate view and market expectations. The current market pricing increase can be partly attributed to the term premium as the market anticipates stronger economic performance and supportive fiscal policy. In addition, the recent speeches of Fed officials have been relatively hawkish, and it is difficult for us to understand why the Fed is suddenly worried about the economy overheating again. The CPI data released last week showed that housing and non-housing service inflation continued to cool, indicating that the underlying downward trend in inflation is still continuing. The ratio of job vacancies to unemployment has stabilized at around 1.1, indicating that the labor market is still cooling compared with the pre-pandemic period. Market-based and survey-based inflation expectations remain at the target level of 2%. In addition, the latest Senior Loan Officer Opinion Survey (SLOOS) shows that the number of mortgage applications remains low and commercial loan demand is weak, indicating that the current policy stance is still restrictive. Therefore, we believe that after December, the Fed will continue to cut interest rates in 2025. In summary, we believe that the market's current pricing of the Fed's neutral interest rate level is unreasonable.
Economic Forecast: We expect participants to slightly increase their expectations for economic growth and inflation in 2024 and 2025, but the forecast for 2026 will remain unchanged.
Press Conference: It is expected that the speech of Fed Chairman Powell will continue to maintain a neutral tone, while retaining the possibility of slowing down the pace of interest rate cuts, which is consistent with the arguments of other Fed officials.
Currently, the interest rate market believes that the probability of the Fed not cutting interest rates at the January meeting is high, but we think this pricing is not very accurate. The probability of 50% is a relatively reasonable pricing in our eyes. We do not expect this pricing to change much this week, because the key data that determines whether there will be a rate cut in January will not be released in the near future. We believe that after the release of key economic data, the interest rate market will predict that the Fed will cut interest rates continuously before (including) the June meeting in 2025, which is also our forecast.