Active week for central banks and mixed for credit markets. High yield outperformed, with Europe the standout, while US investment grade underperformed due to its sensitivity to Treasuries.
The past week has seen significant central bank activity in Europe and Canada, numerous articles devoted to a change in official language on monetary policy in China, and new evidence that the latest attempt to bring back the inflation at its target level in the United States will be a challenge for the Federal Reserve.
It’s been a mixed week for credit markets; high yield outperformed, with Europe the standout, while US investment grade underperformed due to its sensitivity to Treasuries, whose 10-year yields rose by around 20 basis points (bp ). Major stock indexes in developed markets remained stable, while in the commodities sector oil prices rose around 5% after the European Union imposed new sanctions on Russian supplies.
The ECB is getting “a little” closer to its objective
The European Central Bank (ECB) cut its key rate by 25 basis points to 3%, as expected, citing progress in disinflation but also its anticipation of a “slower economic recovery” ECB staff forecasts for GDP growth in 2024 and 2025 were revised slightly downward, to 0.7% and 1.3%, respectively. In its projections, which do not explicitly include the potential impact of the increase in US customs duties, the ECB indicates that the recovery in the region “rests mainly on the rise in real incomes and on the increase in investments of businesses”.
At the press conference following the rate announcement, ECB President Christine Lagarde said the deadline for reaching the 2% inflation target had been “slightly brought forward” to 2025. Futures markets barely reacted, with key rates expected to continue falling before reaching 1.75% in September 2025. The long end of the yield curve rose, while the euro fell slightly by compared to the US dollar.
The Bank of Canada and the SNB are making great efforts
Furthermore, the Swiss National Bank (SNB) and the Bank of Canada (BoC) announced reductions of 50 basis points in their respective key rates. The SNB cut rates to 0.5% due to lower-than-expected inflation and a gloomy economic outlook. This is the largest reduction by the SNB since 2015, during the era of negative rates.
The deterioration of the economic environment was also the main reason for the Bank of Canada’s decision to lower rates to 3.25%. With an unemployment rate of 6.8%, its highest level in three years, and an increase in delinquencies on consumer credit, the Bank of Canada estimated that a greater reduction was justified.
It’s time to let go
In what state media agency Xinhua called a “crucial meeting” on December 9, the Chinese government politburo said it would take stronger measures to stabilize growth and address the country’s economic challenges. . Particular attention was paid to the change in official language on monetary policy from a “cautious” to a “moderately accommodative” approach, the first time such wording has been used since 2011.
Although markets have been disappointed by recent fiscal policy announcements, the change in language should not be taken lightly. China’s stimulus measures are deliberately aimed at doing “just enough” rather than “whatever it takes”, as former ECB President Mario Draghi promised in 2012 during the crisis. sovereign debt in the euro zone. The government wants to achieve its economic growth goals, but without fueling a boom-and-bust cycle.
The change in monetary policy stance has triggered significant moves in Chinese government bonds, with 10-year yields falling to a record low of 1.77% last week (see chart of the week, below).
Another issue occupying the Chinese government’s attention is the possibility of a new trade war with the United States when Donald Trump begins his second term in January. During Trump’s first term, China responded to U.S. tariffs by significantly weakening the yuan against the dollar. It is increasingly expected to use the same tactic again, with Reuters reporting that the People’s Bank of China has “considered the possibility” of weakening the yuan by 3.5% from its current level .
Of course, there are other tools to use in a trade war. In a sign that he is ready to fight fire with fire, Chinese President Xi Jinping has taken a step ahead of Trump by launching an investigation into artificial intelligence giant Nvidia, banning exports of rare materials having military applications and by restricting sales to the United States and Europe of components used in the manufacture of drones.
You can ring my bell….
Donald Trump was in exuberant form this Thursday when he rang the opening bell of the New York Stock Exchange, under the gaze of a “who’s who” of Wall Street executives. In a brief speech, Mr. Trump promised to build “an economy like no one has ever seen before” and, in an interview with CNBC, he reiterated his promise to cut corporate taxes by 21% to 15%, but only for companies manufacturing in the United States.
Meanwhile, the latest inflation data showed that the final step to reaching the Fed’s 2% target is proving difficult. The consumer price index rose 0.3% in November on a seasonally adjusted basis, after increasing 0.2% in the previous four months. Over a 12-month period, the CPI increased by 2.7%, with food prices increasing by 4%. The producer price index for final demand increased by 0.4%, largely driven by a 0.7% increase in goods prices, while the price of services increased by only 0. .2%.
These numbers are unlikely to dissuade the Fed from announcing a 25 basis point cut in the federal funds rate on December 18 – the overnight interest rate swap market puts that probability at 98%. However, there is growing uncertainty over how many cuts it can make in 2025 and debate over what the neutral interest rate should be (a rate that would support the economy while keeping inflation stable).
Is the fourth time the charm?
In our previous weekly market commentary, we discussed the political drama that unfolded in France and South Korea, with former French Prime Minister Michael Barnier losing a vote of no confidence in parliament, which led to the fall of his government, and the short-lived imposition of martial law by South Korean President Yoon Suk Yeol.
Events continued in both countries last week. In France, President Emmanuel Macron named his fourth prime minister of the year on December 13, with François Bayrou the latest in the hot seat Bayrou, leader of the European Democratic Party and the Democratic Movement, ran unsuccessfully for the presidency three times and is considered an ally of Macron.
Barnier’s failure resulted from a failed attempt to push through an austerity budget without parliamentary approval, ostensibly to put the country’s deteriorating fiscal situation back on track. If Mr. Bayrou had any doubts about the challenge that awaits him, he had confirmation in the form of an unforeseen change in France’s sovereign rating by Moody’s, which was lowered from Aa2 to Aa3 the same day of his appointment.
Moody’s said the rating downgrade “reflects our view that the country’s public finances will be significantly weakened over the coming years. The probability that the next government will sustainably reduce the scale of budget deficits beyond next year is now very low.
Meanwhile, in South Korea, things have gone from bad to worse for President Yoon, with the country’s parliament voting to impeach him on December 14. He is now suspended from his official duties and his fate is in the hands of the Constitutional Court. If the Court decides to accept the impeachment motion, Yoon will be officially removed from office, paving the way for a presidential election.
This is Muzinich’s last weekly commentary until the new year. On behalf of Muzinich, we wish you happy holidays and a 2025 full of health and prosperity.
Chart of the Week: Chinese government bond yields hit new low
Source: People’s Bank of China, as of December 13, 2024. For illustrative purposes only.
