The Federal Reserve did not quite deliver on market expectations for a “hawkish cut.” In addition to restarting quantitative easing, communications emphasized labor market weakness rather than the continued failure to meet the inflation target. Markets focused on the divergence between the Fed and other central banks like the ECB, which has finished cutting and will likely hike next; consequently, the dollar sold off across the board. The only major exception was the Japanese yen, which continues to be hobbled by fears of fiscal expansion and the Bank of Japan’s slowness in hiking rates. Notably, U.S. long-term yields failed to benefit from the Fed’s dovishness and ended the week significantly higher even as the dollar sold off, underscoring the difficult task ahead for the U.S. central bank.
Enrique Díaz-Álvarez, Chief Economist at Ebury said: “This week’s central bank meetings should underscore the increasing divergence in monetary policy across the major economic areas. While the Fed continues to cut rates despite high inflation, the Bank of Japan is expected to hike on Friday. Meanwhile, the ECB holds rates and the Bank of England cuts on Thursday. The week is full of critical macroeconomic releases out of the U.S., starting Tuesday with the belated release of the November labor market report and ending Thursday with the November inflation report. Amid the storm of data and monetary policy decisions we will pay extremely close attention to long term rates worldwide, as market patience with inflationary policies worldwide seems to be wearing thin.”
GBP
This week is shaping up to be a critical one for the pound. The Bank of England meeting Thursday will be preceded by the October labor market report (Tuesday), December flash PMI indices of business activity (Tuesday) and November CPI inflation (Wednesday). Expectations are for the same stagflationary combination that is making monetary policy unusually difficult: a labor market that continues to shed jobs and stubbornly high inflation significantly above the central bank’s target. We still expect another rate cut to 3.75%, but it isn’t clear when or even whether the Bank of England can continue its rate cutting cycle unless inflation starts trending decisively down.
EUR
Recent commentary by ECB officials, particularly Isabel Schnabel, confirms our view that the ECB’s rate-cutting cycle is over and the next move is more likely to be a hike than a cut in rates. We expect this week’s PMI indices to support this hawkish messaging by confirming that the Eurozone’s economy remains surprisingly resilient. As a result, the gap in short-term rates across the Atlantic is shrinking fast. This, combined with the emergence of Eurozone assets as an alternative to the U.S. dollar should remain a tailwind for the common currency over the medium term.
USD
The fog over the state of the U.S. economy should in large measure dissipate this week. The non-farm payroll report on Tuesday is expected to show a labor market that is still generating new jobs, contrary to Powell’s downbeat comments at the Fed’s post-meeting presser last week. The CPI for November will actually cover two months of price increases. While it’s expected to show that no further progress has been made in bringing U.S. inflation down to the Fed’s target, the dispersion in predictions is unusually wide due to the uncertainty. By week’s end we should have a much clearer idea of the state of the Fed’s competing goals—low inflation and full employment—as we head into 2026.
