The US curve starts to price in a greater-than-50% probability of a rate cut from the Fed in Q2 next year

But is this likely given the current lie of the land, particularly the robustness of the US economy compared to the paucity on show in Europe?

If we look at market-based pricing of central bank policy, the US curve starts to price in a greater-than-50% probability of a rate cut from the Fed in Q2 next year but the ECB and BoE are not seen cutting until later in the year. Economic forecasters also appear to think that the Fed could cut from Q2 next year but put rate cuts in the euro zone and UK as Q3 events, not Q2. Now clearly the difference in the timing might not be more than just a few months but it does seem strange in some respects.

For a start, it is not as if the Fed sees much more rapid progress on inflation than the others. If we compare Fed and ECB forecasts, we see that they are pretty close. The ECB sees the core CPI down to 2.9% in 2024 and 2.2% in 2025 while the Fed’s core PCE price forecasts are 2.6% and 2.3% respectively.

If we look at current growth dynamics, there clearly seems to be reason to expect the ECB and BoE to start cutting rates before the Fed. This week’s Q3 GDP data from the US is expected to show an annualised rise of over 4% while it seems that the best the euro zone might do is to stay out of negative territory.

For while a lot of the focus has been on the various Nowcast measures of current GDP in the US, which have been very elevated, it is worth noting that a similar measure in the euro zone, the Bank of Italy’s euro Coin measure has been below zero in not just the last four quarters, but also for Q3. This is the longest run of negative results since the euro zone debt crisis. Now clearly the economic landscape could change.

The US could, for instance, start to see an economic collapse under the weight of policy tightening and that might be why the market is priced for the Fed to ease first. But even here there seems to be reasons for caution.

For a start, we know that the fiscal situation in the US has been far looser than the euro zone and, even though the stimulus is flagging it still appears more supportive than the euro zone. If we use OCED forecasts for the structural budget deficit we see that the US deficit was 7% of GDP in the year before the pandemic and slid to as much as 12.3% of GDP in 2020 before rebounding to its projected level of 4.6% in 2024.

In contrast, the major euro zone countries such as Germany, France and Italy started with deficits of between 2% and 4% of GDP in 2019, and are still projected to be smaller than the US in 2024 at between 2% and 4% of GDP. The UK appears even stingier on this measure.

So why does the market seem to think that the Fed will move first? Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said it might be simply due to the fact that the US is often seen as the leader. It was some distance ahead of the ECB at the start of the tightening cycle (but not the BoE) and the market may think it will be a case of ‘first in, first out’. It might be due to the fact that the FOMC members are, on average, forecasting lower rates next year while don’t know what the ECB and BoE think.

“One explanation that we think possibly sits a bit better relates to wages. Our sense is that European central banks will want a clear sign that wage pressures are easing to an extent that’s consistent with their inflation targets before easing. The problem for the ECB is that wage information is delayed and much of the important information comes from the wage rounds among major s. The ECB itself has admitted that this might mean clear information on the trend in 2024 wage growth might not be known until after the spring of next year and the BoE could be in a similar bind given concerns about the accuracy of wage data and the prevalence of wage awards to be granted in April (as well as January). This being said, while there might be some reasons for the market to order the easing cycle in the way it does, we think there’s a growing chance that it is wrong”, said Mr. Steve Barrow.