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For The First Time Since The Covid Crisis, There Are More Global Rate Cuts Than Hikes

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by Tyler Durden
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Two weeks ago, after Powell essentially admitted the Fed would not hike any more and that the July rate hike was the last one, we reminded readers that it takes on average 8 months between the last Fed hike and the first rate cut, suggesting that the Fed would begin cutting rates in March, something the market quickly started pricing in and to which it currently assigns about a 30% probability (and, as recently as a few days ago, 87% odds of a May rate cut).

To be sure, this wouldn't be the first time the market has gotten ahead of itself in pricing in Fed rate cuts, and as DB's Jim Reid calculated last week, this would be at least the 7th time in this cycle that markets have seen a clear reaction to a potential dovish pivot.

On the previous 6 occasions, those hopes were dashed since inflation remained too high for the Fed to be comfortable cutting rates (assuming, of course, that the Fed hasn't quietly agreed to raise its inflation target to 3% or more). Indeed, core CPI has been above their 2% target since early 2021, and the Fed's dot plot is still pointing to a more hawkish stance for policy relative to market pricing. Moreover, a consistent story of this cycle so far has been that markets have pushed out the timing of future rate cuts.

Clearly all that could change quickly if unemployment spiked or inflation fell further. But in light of this repeated pattern, DB ran through the 7 times that speculation has previously risen about a dovish pivot from the Fed. Here is the snapshot (full report available to pro subscribers in the usual place):

7 times this cycle that markets have priced in a more dovish path for the Fed

  • 1. November 2023: Weak data releases and a downside surprise in the CPI lead markets to bring forward the pricing of Fed cuts.

Reaction: The S&P 500 has seen a sustained rally, including its best 2-week performance of 2023.
November so far has seen a succession of news that’s led investors to price in a growing likelihood of rate cuts. At the start of the month, the ISM manufacturing release came in beneath expectations at 46.7, and Fed Chair Powell said after the FOMC meeting that the Committee was “proceeding carefully”. Then on November 3, the jobs report showed that the unemployment rate had risen to 3.9%, the highest since January 2022. And only yesterday on November 14, the CPI release surprised to the downside, with year-on-year core CPI falling to a two-year low of 4.0%. In light of this, investors have brought forward their expectations of the first cut. For instance, the chances of a 25bp cut from current levels by the May meeting have gone up from 8% at the start of the month to 87% now.

  • 2. March 2023: The banking turmoil following SVB’s collapse led to growing anticipation that central banks had finished hiking rates altogether.

Reaction: Yields on 2yr Treasuries fell back significantly from a peak of 5.07% on March 8 to 3.77% by March 24.
At the height of the banking turmoil in March, there was a strong sense after the Fed’s March hike that this could well be the last move. In fact, right after the March meeting, futures were pricing in that the Fed would have cut rates by 49bps by the November meeting. But in reality, they actually hiked by 50bps by November, with further hikes in both May and July.

  • 3. Late September/Early October 2022: Major market turmoil centred on the UK leads markets to price in more rate cuts for 2023.

Reaction: S&P 500 up +5.7% in 2 days over October 3rd and 4th, marking the biggest 2-day rally since April 2020.
The significant cross-asset selloff in September 2022 led to growing chatter that something might be about to break in financial markets, particularly given the turmoil centred on the UK after the mini-budget. In turn, these fears led markets to price in more rate cuts for 2023, thus supporting a brief equity surge. By October 3rd 2022, markets were pricing in that the Fed would only pursue 137bps more rate hikes. But that swiftly unwound, and by October 20th, they were pricing in 194bps of further rate hikes. In reality, they have since delivered 225bps of rate hikes to date.

  • 4. July 2022: Global recession fears and a weak inflation print sees talk of slower rate hikes resurface.

Reaction: S&P 500 advances +9.1% over July 2022, its largest monthly advance since vaccine news in November 2020
As Summer 2022 began, there was increased chatter about an imminent global recession. Oil prices had fallen noticeably, and the tailwind from falling gasoline prices meant the July CPI reading showed an outright fall in prices for the first time since May 2020. All this led to speculation about a dovish pivot, which was fuelled by comments from Chair Powell himself, who said that as “monetary policy tightens further, it likely will become appropriate to slow the pace of increases”. As a result, the S&P 500 rallied over +13% between mid-July and mid-August. However, Chair Powell then delivered a very hawkish speech at Jackson Hole, which put to bed any remaining hopes that they might be about to shift their policy stance.

  • 5.May 2022: Rising risks to global growth see investors take out expected tightening.

Reaction: S&P 500 experienced its strongest weekly performance of 2022, gaining +6.6% in the week ending May 27. To date, that is still the best weekly performance since 2020.
Back in spring 2022, there was another shift in the market narrative. Investors were becoming concerned about multiple growth risks, including the rate hikes that had started, China’s continued zero-Covid strategy and Russia’s invasion of Ukraine. As a result, futures began to price in less Fed tightening, and May marked the first time in 10 months that futures lowered the expected amount of tightening by end-2022. But ultimately, the May CPI release in early June surpassed all estimates, paving the way for the Fed to start hiking by 75bps for the first time since the 1990s.

  • 6. Late February/Early March 2022: Russia’s invasion of Ukraine sees the Fed commence hikes with 25bps rather than 50bps.

Reaction: 10yr bund yields move back into negative territory, 10yr Treasury yields also fall back to 2-month low, S&P 500 advances +3.6% over March
After Russia’s invasion of Ukraine, the initial concern from a market perspective was more focused on the growth risks rather than the inflation risks. At one point there were even questions about whether the ECB would be able to hike at all, sending yields on 10yr bunds back into negative territory. For a sense of what was being said at the time, Olli Rehn of Finland’s central bank said that “given the new situation, we need to take a moment of reflection as regards the speed and way of a gradual normalization of monetary policy”. And at the Fed, the invasion meant that they started off their hiking cycle with just a 25bps move, rather than the 50bps hike that had been widely anticipated beforehand. In the end however, as the worst fears about a broader escalation involving more countries didn’t materialise and the spike in commodities boosted inflation, central banks grew more concerned about inflation persistence and second-round effects, putting any slow-down in rate hikes off the agenda.

  • 7. November 2021: Investors doubt how fast central banks can hike after the Omicron variant appears.

Reaction: After an initial selloff after Omicron was discovered, the S&P 500 rebounds to hit all-time highs again by late-December 2021.
When the Omicron variant first appeared, there were serious concerns that it could overwhelm health services again or even evade vaccines, bringing into prospect that the pandemic could still be a substantial issue for policymakers in 2022. In the end, it proved to have a lower mortality rate than previous variants, but the initial reaction in markets was swift. Although the major central banks hadn’t started tightening yet, futures immediately reacted and the subsequent trading sessions saw them push back the timing of when the first Fed rate hike was fully priced from June 2022 to September 2022.

* * *

And yet, as Reid expands in his latest chart of the day, even though the other six attempts to price in a dovish central bank eventually reversed, it doesn’t mean this one will, especially since now something has clearly changed: according to Deutsche Bank, there are more global cuts coming through than hikes, which is the first time that’s been the case since January 2021.

As shown above, at the moment the number of hikes are a fraction of where they were at their peak in summer 2022 as the global economy has slowed to a crawl (and even Biden's massive deficit-spending, stimulus-funded fake growth is fading fast). At the same time, cuts have very slowly been building up, but the general theme has been a much lower level of global central bank activity. Of course, that will change as the global slowdown gets even worse and as we enter the election-heavy 2024.

The second chart looks at it on a rolling 12 month basis but goes back further, albeit with less country data available in the early stages.

So, for Jim Reid, the big question is "whether we’re “higher for longer” now or whether we will soon see a big global easing cycle." Reid's view is that unless the US sees a recession, it will be tough to see a big imminent global easing cycle. After all, inflation is still above target levels across the major economies. However, if we do get the recession that the inverted yield curve has been pricing for almost two years, then expect a huge flip in the first graph and many more cuts than the market is pricing.

One final interesting point from Reis is that at the moment is that cuts are priced in on a soft landing scenario, "so I think they might be right for the wrong reasons, and eventually you’ll see more cuts than are priced in due to a harder landing than is priced."

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