Central Banks Gear Up for Tough Final Mile in Inflation Battle

Exclusive insight for TMI subscribers! Northern Trust Asset Management share a monthly market commentary for treasurers.

Eurozone Market Update

The European Central Bank’s (ECB) Governing Council maintained their three key interest rates for the third successive month, as widely anticipated by the markets. The tone of the discussion became slightly dovish and more favourable to medium-term cuts (in the summer at the earliest), as suggested by President Christine Lagarde’s statements during the month. The council outlined that “the declining trend in underlying inflation has continued”, while the reference to “domestic price pressures remain strong” was removed. The statement also highlighted “tight financing conditions are dampening demand, and this is helping to push down inflation”. The future course of policy remains data-dependent, and the statement continued to stress that policy rates will be maintained at current levels for a sufficiently long time to substantially contribute to the ECB’s inflation goal. These comments moved market expectations of a first cut to April, from March, with a 90% chance of an April cut priced in. We think this is still too early and that June is more likely.

_{Source: Bloomberg, data as of 31 January 2024}

UK Market Update

As expected, the Bank of England’s (BoE) Monetary Policy Committee left the bank rate unchanged at 5.25%, but the voting split surprised markets. Two committee members preferred a 25 basis point rate increase while one member favoured a 25 basis point rate cut, with six voting to keep the rate unchanged. The updated economic forecasts indicated that risks to the committee’s inflation forecast are now more balanced, although key indicators of inflation persistence remain elevated. Governor Andrew Bailey reiterated that the committee needs to become more confident in the persistent fall of inflation. Indeed, December’s annual inflation data surprised to the upside for both headline (4% from 3.9%) and core inflation (unchanged at 5.1%), reminding markets that the road to 2% remains bumpy. Bailey stated the BoE has moved from asking “How restrictive do we need to be?” to “How long do we need to be restrictive for?”.

_{Source: Bloomberg, data as of 31 January 2024}

US Market Update

The Federal Reserve’s Federal Open Market Committee (FOMC) concluded its first meeting of 2024 by keeping rates unchanged, as widely expected by the markets. The FOMC’s policy statement highlighted that it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably towards 2%”. Chair Jerome Powell further clarified that a March rate cut was unlikely. Markets took heed by meaningfully reducing the implied likelihood of a March cut to approximately 35% from over 70% earlier that day. During the press conference, Powell noted that the FOMC believes that the federal funds rate is “likely at its peak for this tightening cycle” and that, if the economy evolves as widely expected, they would likely start cutting rates “at some point this year”. But he stressed that they are “prepared to maintain the policy rate at its current range for longer, if appropriate”.

_{Source: Bloomberg, data as of 31 January 2024}

Looking Ahead

As universally expected, the Fed, ECB and BoE kept their policy rates unchanged in their first policy meetings of 2024, but these meetings were far from dull. All three central banks were cautiously optimistic. They have made good progress on the inflation front, but the job is not yet done, and more data is required before they can start their much-anticipated cutting cycles. Crucially, they took the first transitionary steps by removing the specific reference to additional tightening in their forward guidance and concluding that interest rates are sufficiently tight. The central banks are gaining confidence that their tightening cycles are finally having the desired impact on inflation. However, we believe they will err on the side of caution to avoid loosening too early. Further information on inflation and wages is required before they will feel comfortable commencing their cutting cycles. We agree with the market that cuts are coming this year, but we still believe that the market’s timing and magnitude are too aggressive.

Chart of the Month

_{Source: Bloomberg as of 31 January 2024}

_{IMPORTANT INFORMATION}

_{For Asia-Pacific (APAC) and Europe, Middle East and Africa (EMEA) markets, this information is directed to institutional, professional and wholesale clients or investors only and should not be relied upon by retail clients or investors.}

_{The information contained herein is intended for use with current or prospective clients of Northern Trust Investments, Inc (NTI) or its affiliates. The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. Northern Trust Asset Management’s (NTAM) and its affiliates may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, its accuracy and completeness are not guaranteed, and is subject to change. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor. This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. Indices and trademarks are the property of their respective owners. Information is subject to change based on market or other conditions.}

_{All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, advisor risk, and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe NTAM’s efforts to monitor and manage risk but does not imply low risk.}

_{Past performance is not a guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by NTAM. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and/or alternative strategies in general. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Net performance returns are reduced by investment management fees and other expenses relating to the management of the account. Gross performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. For additional information on fees, please refer to Part 2A of the Form ADV or consult an NTI representative.}

_{Forward-looking statements and assumptions are NTAM’s current estimates or expectations of future events or future results based upon proprietary research and should not be construed as an estimate or promise of results that a portfolio may achieve. Actual results could differ materially from the results indicated by this information.}

_{Hypothetical portfolio information provided does not represent results of an actual investment portfolio but reflects representative historical performance of the strategies, funds or accounts listed herein, which were selected with the benefit of hindsight. Hypothetical performance results do not reflect actual trading. No representation is being made that any portfolio will achieve a performance record similar to that shown. A hypothetical investment does not necessarily take into account the fees, risks, economic or market factors/conditions an investor might experience in actual trading. Hypothetical results may have under- or over-compensation for the impact, if any, of certain market factors such as lack of liquidity, economic or market factors/conditions. The investment returns of other clients may differ materially from the portfolio portrayed. There are numerous other factors related to the markets in general or to the implementation of any specific program that cannot be fully accounted for in the preparation of hypothetical performance results. The information is confidential and may not be duplicated in any form or disseminated without the prior consent of NTAM.}

_{This information is intended for purposes of NTI and/or its affiliates marketing as providers of the products and services described herein and not to provide any fiduciary investment advice within the meaning of Section 3(21) of the Employee Retirement Income Security Act of 1974, as amended (ERISA). NTI and/or its affiliates are not undertaking to provide impartial investment advice or give advice in a fiduciary capacity to the recipient of these materials, which are for marketing purposes and are not intended to serve as a primary basis for investment decisions. NTI and its affiliates receive fees and other compensation in connection with the products and services described herein as well as for custody, fund administration, transfer agent, investment operations outsourcing and other services rendered to various proprietary and third party investment products and firms that may be the subject of or become associated with the services described herein.}

_{Northern Trust Asset Management is composed of Northern Trust Investments, Inc. Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K, NT Global Advisors, Inc., 50 South Capital Advisors, LLC, , Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.}

_{NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE}

_{© 2024 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A.}