An Early Pivot for the Fed Could Have Costly Consequences
According to a recent report, the Federal Open Market Committee (FOMC) is expected to maintain steady rates in the upcoming week. However, due to progress on inflation despite the Red Sea tensions, some market participants anticipate an early pivot as soon as March 2024. This has resulted in a significant disparity between the Fed’s restrictive monetary stance and the easing financial conditions, particularly the buoyancy of the stock market. The report estimates that a Fed rate cut in March could potentially push up inflation by 0.5 percentage points by the end of the year, reaching 2.9%. This could jeopardize the central bank’s credibility. Despite the risk of premature monetary policy easing leading to renewed bouts of inflation, the expectation is for the Fed to pivot in June rather than March.
Inventory Glut Impacting Various Sectors
Since 2022, most manufacturing sectors have been grappling with an inventory glut, particularly in Europe and China, as demand has been on the decline. Slower inventory liquidation in Europe could potentially act as a buffer against potential supply-chain disruptions stemming from the prolonged Red Sea crisis. However, the automotive sector is facing challenges, with a low inventory-to-sales ratio making it highly susceptible to supply shocks arising from the Red Sea crisis. Higher inventories are already eroding pricing power for European and US companies, particularly in the textiles, furniture, metals, paper, and chemicals sectors. Cost absorption is likely to become the norm in 2024.
Eurozone’s Soft Landing
Despite subdued private consumption and investment, the Eurozone is on track for a soft landing. The labor market remains robust, real incomes are increasing, and the output gap is significantly negative, providing room for a mechanical catch-up with potential levels. January PMI indexes indicate limited additional recession force, with business activity in the manufacturing sector showing improvement, albeit at relatively low levels. Price indicators suggest minimal upside risk for the Eurozone’s inflation outlook, and with stable energy prices, disinflation is expected to gain traction, potentially leading to a first ECB rate cut in July. The latest ECB Bank Lending Survey indicates that the most significant impact of the tightening has passed its peak.
