Stay informed with free updates
Simply sign up to the Global inflation myFT Digest — delivered directly to your inbox.
…
Silent night, soft-landing night,
Hawks do quake at the sight;
Blessings stream from a steady R*,
Econo-mists sing Alleluia,
Price stability borne!
Price stability borne.
Readers, we gather here to observe that inflation is slowing worldwide — even in the UK!
That makes it a good time for a victory lap from the sellsiders who believe a soft landing is in the works for the economies that experienced high inflation after the Covid-19 pandemic.
Goldman Sachs in particular has been outspoken in arguing that central bank officials have accomplished most of the work needed to control inflation. Now the bank’s top economist Jan Hatzius has published a note about the ongoing “Great Disinflation”:
Looks pretty good!
In fact, the economists forecast that US core PCE inflation will fall below 2.5 per cent in the first quarter of 2024.
That’s not to say that US interest rates are going to fall as far as the market predicts, however. Derivatives markets are pricing in more than 130bp of cuts, while GS predicts just 75bp of easing:
We see the committee delivering at least three back-to-back 25bp cuts, probably in March, May, and June.
Such an adjustment would resemble the 1995, 1998, and 2019 episodes, and anything less would raise the question “why bother?” But 75bp in cuts would still leave the funds rate at 4½-4¾%—a level 200bp above the FOMC’s median estimate of the longer-term funds rate — at a time when year-on-year core PCE inflation is close to 2%. We have therefore penciled in two further quarterly cuts in the second half of 2024, for a total of five cuts in 2024, as well as three quarterly cuts in 2025 that take the funds rate down to 3¼-3½% in September 2025.
GS’s estimates for interest-rate cuts in the EU and UK were slightly more cautious in Hatzius’ note. But Wednesday’s lower-than-expected UK inflation report has prompted the bank’s economists to predict the BoE’s first rate cut in May, a month sooner than before.
In fact, Hatzius & Co are forecasting looser monetary policy in lots of places, compared to just one month ago:
Notably, financial conditions are already easing as a result of the Fed’s recent dovishness. That has fuelled a rally in risky markets, Hatzius writes:
The combination of solid growth, sharply declining inflation, easier monetary policy, and lower long-term rates is exceptionally friendly for risk asset markets, and both our equity and credit strategists have therefore upgraded their return forecasts materially. If we are right about the economic outlook, the recent easing in financial conditions has further to run, which would reinforce the positive FCI growth impulse for 2024 and could result in further upward revisions to our already above-consensus growth forecasts.
The relationship between financial conditions and inflation is fuzzy at best — see the decade after the 2008-09 global financial crisis — and for now the sellside isn’t digging too far into any potential inflationary effects of a rally in risky assets.
Steven Blitz, chief US economist for TS Lombard, says that the wealth effects of loose financial conditions (aka “line go up” for stocks and home values) isn’t a liability, but a tool the Fed has learned to use to prevent recession:
The power of Powell’s gift resides in liquidity and stock market wealth and breadth, it is also what has made flipping the economy into recession so difficult. It is hard to create a “Minsky moment” when building speculative leverage belongs to the central bank. More to the point, each time in the past 18 months or so, when the equity market has been on the brink of a sustained bear market, the Fed responded. This FOMC is not going to sacrifice household savings and faith in equities to the cause of reaching 2% inflation sooner rather than during some two-to-three-year time frame if recession can be avoided. Today, they will ignore still high service inflation (with or without rent or medical services) while deflating goods prices pull total core inflation ever closer to 3%.
In other words, investors can relax over the holidays this year. Blitz writes that there’s no need to worry about Fed Chair Jay Powell turning into a “Grinch” come January.
