Will the Fed Follow ECB's Lead on Rate Cuts? | Episode 141 | 06-06-24

In the latest episode of "Markets with Megan," the focus is on the European Central Bank's (ECB) recent decision to cut interest rates and the potential implications for the Federal Reserve (Fed). The ECB's rate cut, though anticipated, has stirred conversations in financial circles, especially regarding how it might influence the Fed's future actions. This blog post delves into the intricacies of the ECB's policy shift, the significant reduction in Eurozone inflation, and the potential ripple effects on global markets.

The ECB's mandate is to ensure price stability across the Eurozone, which comprises 20 diverse countries. Unlike the Fed, which has a dual mandate of controlling inflation and ensuring maximum employment, the ECB's sole focus on price stability means its policies can sometimes appear more singular in purpose. This latest rate cut comes after a notable reduction in Eurozone inflation, which has plummeted from a peak of 10.6% to a much more manageable 2.6%. This drastic decrease has provided the ECB with the latitude to ease monetary policy, a move they believe will support the ongoing economic recovery in the region.

However, the ECB's rate cut was not without its controversies. The decision, though expected, was met with some internal dissent. One central bank governor voiced opposition, highlighting the complexities of setting a unified monetary policy for such a diverse economic landscape. The ECB's challenge is unique, given it must balance the needs of multiple economies, each with its own fiscal dynamics and challenges. This delicate balancing act often requires the ECB to adopt a cautious approach, ensuring that no single economy is disproportionately affected by its policy decisions.

Christine Lagarde, the President of the ECB, delivered hawkish comments alongside the rate cut, signaling that the bank remains committed to maintaining restrictive policy measures. This stance is crucial as it reassures markets that the ECB is not shifting towards a more dovish or accommodative policy stance, which could risk reigniting inflationary pressures. Lagarde's comments have had a notable impact on bond markets worldwide, with yields rising and prices declining as investors recalibrate their expectations.

Don't miss our insights on whether a December rate cut is on the horizon or if the Fed will hold off until next year. Listen for more.

The question today becomes is the clock ticking for the Federal Reserve? This is your regular segment of Markets with Megan. It's Thursday, june 6th and, as expected, this morning we got the rate cut from the European Central Bank, following the Bank of Canada, which was the first major G7 country to actually cut interest rates. But the ECB's rate cut was expected. It wasn't a surprise and I just want to explain why they have done it, what it means for the Fed and does it mean that the Fed now is the clock is ticking for the Fed and there is some sense of urgency for them to move. So, first of all, keep in mind the ECB and the Federal Reserve have two different mandates. The ECB's mandate is to have price stability, so control inflation. But the Federal Reserve has to control inflation while having maximum employment. So they have two different sides from their mandate. What we've seen in the European region is that inflation has come down. It's come down substantially. We've seen some sticky prints in the past month or so. So there was one central bank governor who actually disagreed with the decision, but they did decide to cut interest rates.

The European Central Bank also, keep in mind, is in charge of many different countries, not just like the US. It's one currency, one country. They have 20 different countries that they have to set monetary policy for, so their economic environments can be very different. There may be economies that are really struggling. There may be the economies that are doing a bit better. So they have to kind of toe a very fine line here when they're setting monetary policy. The one thing when it comes to inflation, the European Eurozone inflation has come from 10.6% and this is at the headline level all the way down to 2.6%. So it's fallen from a much higher level and fallen more than we've seen here in the US. If you look at the peak in our headline inflation at 9.1%, we've come down to 3.4%. That's just looking at numbers. So they've seen a very big improvement in their inflation picture.

But what they did today and why you're seeing bond markets sell off on this is that they delivered this rate cut with what's considered a hawkish tone, and we have often said that sometimes the comments that come out of these meetings are equally as important as the actual action itself. And what Christine Lagarde did was she made the comment that they still are promoting restrictive policy. This is basically fine tuning. They do believe that inflation has come down enough so that they can modestly reduce interest rates. They made no commitment whatsoever to this being a start of a cycle or them cutting interest rates again in July or September. So the markets from a bond market perspective, we've seen yields rise and prices decline across the globe, with those hawkish comments.

Now, what does this mean for the Fed? The Fed can still be, we think, flexible. We don't think that this puts them on any timeline. Remember that the European Central Bank is also not too far out of a negative interest rate policy that they struggled with for many, many years leading up to the pandemic. This may simply be the fact that it's too fresh in their minds and they want to err on the side of caution and not get back to a deflation, disinflation type of environment where they may have to cut interest rates back to zero. So they'll let economic growth run a little bit, they'll let inflation stay a little bit higher. They actually even increased their inflation expectations for this year, in 2025. So they don't necessarily think that inflation has improved and they're entering this major deflation or disinflationary environment, but they just want to make sure they don't have to get back there. So we can consider that to be maybe one of the incentives with the European Central Bank as well. So I apologize.

Going back to the Fed, we don't think it changes anything Right now. Economic growth is still. We had a very strong economic growth last year. The European Union had two negative back-to-back prints, so we're in a different economic situation here. We also still have this sticky inflation that we're struggling with. The Fed just simply does not have enough evidence that we can't see inflation tick back higher. If they were to cut rates we still lean towards a December rate cut maybe, but more towards the beginning of next year. For the Federal Reserve, the only thing that would change that opinion is if we saw economic growth really start to deteriorate at a rapid fashion. We're seeing it slowing that. This is primarily consumer-driven, but we just think that inflation is still too sticky for them to make any moves anytime soon. That's all we have today. If you have any questions or comments, please feel free to reach out to podcasts at Verdence. com. Thank you.