Weekly Buzzer: Is it still too early for interest rate cuts?

If you’re looking for interest rate cuts soon – and plenty of experts are – the Organisation for Economic Co-operation and Development (OECD) thinks you’re kidding yourself.

What’s holding back the central banks?

In its just-released global outlook, the international organisation says lingering inflation will force central banks in the US and Europe to keep rates higher for longer than investors expect.

It warned that the cuts could only come after clear signs that underlying price pressures were being lowered. While there have been falls in core inflation, which excludes more volatile food and energy prices, more than half of the items in inflation calculations for the US, the UK, and the Eurozone still showed annual rates above 4%.

The OECD predicts that rate cuts will begin in the US in the second half of 2024, and across the Eurozone in the spring of 2025. That’s considerably later than what the market is estimating – anticipating cuts as early as next April for the US and May for Europe.

Why does the market predict early cuts?

Though Eurozone inflation has now fallen to 2.4%, close to its 2.0% target, both the European Central Bank (ECB) and the Bank of England (BoE) have continued to emphasise the notion that interest rates will remain higher for longer. But investors don’t seem to be getting the message. Their biggest concern: growth.

Data last week suggested that the Eurozone and UK are headed for another period of low growth. And the OECD warns that, although the global economy may be on track to avoid a hard landing, growth is still weak in many countries and won’t push further until 2025, when real (inflation-adjusted) incomes finally recover from the inflation shock.

So, traders now figure that central banks will have to cut rates to prevent hamstringing growth any further – and they’ll have to do it sooner than they’ve been saying.

As an investor, what does this mean for me?

It’s difficult to say if the market will stick with their predictions of early rate cuts – after all, we’ve seen how easily market sentiments can change. And though there’s been positive news recently on the fight against inflation, it still stands defiant above many central banks’ targets.

Amid uncertainty, it’s crucial to stay on course – it’s far more difficult to try timing the market. When it comes to building your long-term wealth, consider staying invested in a portfolio that’s diversified across different asset classes and regions (our General Investing Portfolios come to mind here!) to help your ride out short-term volatility.

This article was written in collaboration with Finimize.

📰 In Other News

Bitcoin and gold prices have surged – here’s why

Over the last few weeks, the prices of Bitcoin and gold have soared. Bitcoin surpassed $42,000 to reach a 20-month high, and gold is approaching an all-time high of more than $2,100 an ounce. To understand why these assets have jumped – seemingly overnight – our CIO, Stephanie Leung, took to the BBC to share her insights. Here are the highlights from the interview with Asia Business Report host, Arunoday Mukharji.

ARUNODAY MUKHARJI: The two assets have jumped in recent days, as investors bet that the US Federal Reserve will cut interest rates next year after 11 hikes since March 2022. So what is driving this surge that we're seeing?

STEPHANIE LEUNG: There are two factors that drive these two asset classes. The first one is liquidity and the second one is the US dollar. 

In the past few weeks, we've seen easing from China and also from the US – the Fed has actually been injecting liquidity, through running down its overnight repo facility. Also from a seasonality perspective; November, December tend to be actually quite favourable, in terms of financial conditions.

And indeed, the rally in bonds, or the fall in interest rates, have also helped financial conditions to ease in the past few weeks. Hence, we've seen a surge in liquidity in the system and that propels both gold and cryptocurrencies higher.

The next reason is the US dollar. Now, of course, both gold and cryptocurrencies are denominated in US dollars and when the US dollar becomes weaker, that is actually a tailwind for both asset classes. Given that the market is now pricing in increasing probability of cuts starting as early as April next year, the US dollar has been weakening versus most other currencies, including gold and cryptocurrencies.

ARUNODAY MUKHARJI: How far do you expect this rally to go?

STEPHANIE LEUNG: If you look at liquidity (Editor’s note: Our Jargon Buster below breaks this down!), it's still quite supportive and indeed, could be supportive into the first quarter next year. In terms of the US dollar, our view is more neutral. We think that the market may be a bit ahead of itself in pricing in Fed cuts so early.

So the two factors combined means that both cryptocurrencies and gold could still see some more gains, but probably not as much as what we've seen in the past few weeks.

Edited transcript of interview conducted on BBC program, Asia Business Report, aired 5 December 2023.

And that’s not all – Stephanie also took to Bloomberg to delve a little deeper into the market’s expectations (it’s been a busy week!). Can the US economy manage a soft landing? What are the opportunities in China’s on-going growth story?

🎓 Jargon Buster

Liquidity (economics)

On the economic scale, liquidity refers to how much cash is easily accessible in the economy. Central banks, like the Fed or the ECB, can adjust the supply of money through various policies, like raising or lowering interest rates. It's about finding that sweet spot where there's enough liquidity to keep the economy running smoothly, without causing soaring prices.