Investment Institute
Macroeconomics

Dovish “Bivot”

  • 18 December 2023 (7 min read)

  • We were expecting the Fed and the ECB to push back against the market’s aggressive pricing. Only the latter did. The Fed may too relaxed, and the ECB too worried, relative to the intensity of inflation risks in their constituencies.
  • COP 28 was  a mixed bag, with some breakthroughs on green finance and a nice signal on fossil fuel, although implementation will remain, as usual, the crux of the matter. 

After Jay Powell did not push back against market pricing last week, even more aggressive expectations for rate cuts emerged. Some FOMC members tried to “fine tune” the Fed’s communication on Friday, with some effect on the market, but we suspect the verdict will come from the data flow. The Fed President – and the market – might get lucky and we could see the resumption of swift disinflation in early 2024, dissipating the ambiguous message from the November CPI print, but we prefer to maintain our expectation of only 75 bps of cuts next year and brace ourselves for some volatility in the first few months of next year. Christine Lagarde, conversely, was very clear in her refusal to embark on any discussion of rate cuts, but her warnings largely fell on deaf ears at the end of last week, with the market still pricing massive accommodation. Some aspects of the central bank’s forecasts could express a bias towards exaggerating the chances of a price drift ahead. In a nutshell, we think the Fed may be today too relaxed on the capacity of the current macro trajectory to bring inflation back to 2% swiftly, while the ECB may be overly cautious. This keeps us comfortable with our baseline that both central banks will ultimately wait until June 2024 to cut, although this may come too late for the ECB given where the Euro area stands in the cycle. 

Expectations were low for the outcome of COP 28, so the final version of the Stocktake agreed in the UAE last week – explicitly mentioning “transitioning away” from fossil fuels -  probably is a positive surprise. The commitments taken at COP by 50 oil companies controlling 40% of the market were laudable but focus on scope 1 and 2 only. Scope 3 revolves around demand. It was probably illusory to expect much on that front in a global forum. We will now need to monitor the new pledges –  and the means attached to them – in the next wave of NDCs by national governments. We note however that progress is now possible on key aspects of international green finance. 

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