Geopolitical Uncertainty Looms Over 2025 Interest Rate Paths

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

Eurozone Market Update

In October, the ECB unanimously voted to cut the deposit rate by 25 bps to 3.25%, reflecting confidence in disinflation despite ongoing growth risks. This decision diverged from President Christine Lagarde’s comments earlier in September suggesting a likely pause, as a sharp decline in Purchasing Managers’ Index (PMI) data and inflation dropping to 1.7% prompted a reassessment of the economic outlook. The ECB’s press release maintained the forward guidance, stressing a data-driven approach to setting monetary policy. During the press conference, Lagarde emphasised that disinflation is “well on track.” Market expectations for a December cut rose, with speculation of a possible 50 bps reduction gaining traction, particularly after comments from ECB members about ongoing disinflation. However, other ECB officials advised caution against excessive cuts, following the uptick in October's inflation print from 1.7% to 2%, resulting in market expectations of a 50-bps cut in December falling from 41% to 20%.

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

UK Market Update

In early October, BoE Governor Andrew Bailey and Chief Economist Huw Pill expressed differing views on interest rates. Bailey hinted at aggressive cuts if inflation decreases while Pill urged caution due to persistent inflation risks, leading to doubts about a November cut. Bailey’s comments increased market expectations to a 60% chance of a December cut. UK Chancellor Rachel Reeves announced a fiscal package aimed at a 1% GDP stimulus, over 5 years, through tax increases and new borrowing rules. The Office for Budget Responsibility raised growth forecasts for 2024-2025 but warned of rising debt and prolonged inflation risks, suggesting the BoE may keep rates higher for longer. Inflation surprised to the downside across headline, core, and services, leading investors to dial up expectations for BoE rate cuts in both November and December. Our call remains for a November cut with the risk of an additional cut in December if data deteriorates.

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

US Market Update

Recently, the US economy displayed a divergence between solid growth and slowing indicators, with a rising unemployment rate. Throughout the month, several Federal Reserve presidents expressed support for gradual rate cuts. In October, non-farm payrolls increased by 12,000, a significant miss from the estimate of 100,000. This was due partly to both the Boeing strike and the severe hurricanes. The unemployment rate stayed at 4.1%. Average hourly earnings rose by 0.4% month-over-month, and annual wage growth hit 4.0%. PMI and Institute for Supply Management (ISM) surveys highlighted softness in manufacturing but resilience in services, with the ISM services index rising sharply to 54.9. The monthly headline consumer price index increased by 0.2%, while the annual rate eased to 2.4%. The September retail sales report indicated strong consumer demand, as monthly overall sales rose 0.4%.

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

Looking Ahead

As global geopolitical tensions escalate, markets face a wave of uncertainty (see Chart of the Month) that could ripple through economic data and central bank policy. For front-end investors, the focus will be on how these developments shape inflation trends, which could disrupt the current disinflationary trajectory and potentially fuel higher inflation expectations. With the Fed and BoE both meeting in early November, the prevailing geopolitical landscape is unlikely to sway their plans for a 25 bps rate cut at these meetings. We believe the interest rate cut path is unlikely to change for the remainder of 2024, and the ECB and Fed will cut rates in December, bar any severe market stress, while the BoE pauses. The real question is how this volatility will affect the pace and level of cuts in 2025, as central banks remain committed to a data-driven approach while acknowledging these looming headwinds that could inject further uncertainty into proceedings.

Chart of the Month

_{Source: Bloomberg as of 4 November 2024}

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