Euro-Area Macro Outlook with Dirk Schumacher
Data coming out of the euro area remains somewhat lackluster, with no real sign of pick up that the ECB has been expecting. Yet, there are fundamental reasons to believe there will be a pick-up.
Headline inflation has reduced dramatically as is not far away from the 2% target, but it may not reach that target, as the last mile may be more difficult to achieve. While the price of goods has dropped quite sharply, the cost of services continues to hover around the 4% mark, which could be a warning sign that there might be a stickiness in inflation that may warrant some attention from the ECB.
"Headline inflation has reduced dramatically and is not far away from the 2% target, but the last mile may be more difficult to achieve, and the target may not be met."
Dr. Dirk Schumacher, Head of European Macro Research
Looking to wages and the labor market, wage growth is very strong, running at around 5%, which is more than double the historical average. Momentum in the labor market appears to be easing and the unemployment rate has steadily declined.
Wage momentum at this stage may not be as threatening as it seems to core inflation on the surface.
That said, given there’s a lot of uncertainty in estimate and other factors may push inflation up.
Emerging Markets Marco Outlook with Inna Mufteeva
2023 was not a great year for global growth dynamics. The good news for emerging markets though, is that growth has already picked up in 2024 as the headwinds that were keeping growth down are fading out.
Headline inflation too – just like in advanced economies – is declining in EM economies. The main factors driving this progress are moderation in commodities prices, impact of the foreign exchange on certain currencies and imported disinflation from China. Meanwhile, core inflations improved at much slower pace that we’d hope for.
"Growth has picked up for emerging markets as the number of economic headwinds that were keeping growth down are fading out. "
Inna Mufteeva, Credit Analyst
China economic developments will play a key role for a number of emerging markets. While year 2023 was challenging for China, it ended on a positive note with rather strong Q4 that allowed the yearly GDP growth to reach the 5% target. However, the country still has a challenging year ahead with another slowdown in economic activity resulting from a lack of investment and a weakness in demand unless t get more government support. To keep growth even at the 4% - 4.5% range, China will need a bolder monetary or fiscal stimulus.
Looking at the risks for the rest of the year, escalating geopolitical tensions are a key concern, in particular, in the Middle East with a risk of a wider war. Elections will too play a big role in 2024, for both emerging and advance economies.
Interest Rates Outlook with Théophile Legrand
Following the last ECB meeting, where Christine Lagarde was perceived to be dovish by the market as she did not push back the rate cut expectations the market has priced in a first rate cut by April. Then, the market corrected for both the ECB and the Fed, almost two rate cuts that had been expected until recently have been eliminated from the low points that had been reached. Moreover, the idea of rapid rate cuts as early as the first quarter of 2024 has disappeared. Our House view remains more on the conservative side of inflation, with uncertainty on wage growth dynamics, and so we maintain our view that the first cut will take place in June, with the cumulative total for 2024 reaching -125bps, a neutral rate of 2% by mid-June 2025.
Current market pricing is quite aligned with our expectations, and so we don’t see a lot of mispricing against the market.
" While the market is almost pricing a first rate cut in April, we remain more conservative and maintain our house view that the first cut will take place in June. "
Théophile Legrand, European Rate Strategist
Looking at the long end of the Euro curve, we can see that a correction took place between October and December 2023, with a strong rally on US and Euro rates thanks to the negative surprises in EU economic data and bigger progress in the inflation outlook. There’s also a good supply dynamic, given that we are at the beginning of the year and treasuries are issuing a lot of bonds, which has helped to reprice the term premium. The 10Y Bund yield now is close to 2.4% and US treasuries are close to 4.10%. For Euro rates, US macro data is also playing a huge role in the 10-year swaps – so the stronger than expected US macro-outlook led to repricing in Euro rates.
Steepening is indeed the trend of the year for the EUR curve and looking back over the last few weeks, we have seen a quite crowded trading environment. While we are cautious on steepeners, we tend to agree with the market that they will be the trend for the year and we expect to see the ECB ‘green light” coming soon.
