On: December 18, 2023 In: Blog, Fixed Income, Knowledge Centre

14 December 2023

Federal Open Market Committee (FOMC)

  • Federal Reserve paused for the third consecutive time, maintaining current Fed Funds Rate (FFR) at 5.25%-5.50%. The markets reacted positively as the tone from the FOMC confirmed their well-ahead anticipation of the Fed’s dovish pivot since the release of October’s inflation print.
  • Fed statement sees slowing economy and acknowledges inflation progress; press conference hints dovish pivot. The Fed statement switched the word “expanded” to “has slowed” in describing the US economic activity while acknowledging that inflation “has eased” over the past year. The added word “any” prior to “additional policy firming” softens the certainty of further rate hikes. In the press conference, the major change in tone was seen in Powell’s view of policy rates being “at or near peak” in this cycle while stating that policy easing discussions are beginning. He adds that any potential cuts could happen well ahead of inflation reaching their 2% target. This was justified with their view of real progress seen in core inflation and labour market tightness dissipating.
  • Fed’s forecast revision and rate trajectory implies possibility of 3 cuts next year. The change in 2024 FFR median dot plot to 4.6% implies a potential 75bps cut from the current range. The Fed sees slower growth but no recession at least for the next two years as they revised 2024 real GDP growth slightly lower to 1.4% before seeing a rebound to 1.8% & 1.9% in 2025 & 2026 respectively. Notably, they anticipate a faster deceleration in core personal consumption expenditure (PCE) with 2024 estimates lowered to 2.4% from 2.6% projected previously.

European Central Bank (ECB)

  • European Central Bank (ECB) hold rates for the second consecutive time with deposit rates at 4.00%, marginal lending facility at 4.75% and main refinancing rate at 4.50%. This was no surprise to the markets which was already jumping ahead by pricing in policy rate cuts as far as 150bps for 2024 prior to this decision.
  • ECB statement acknowledged easing inflation and announced end to bond-buying. Notably, the phrase “inflation is expected to remain too high for too long” was omitted from the statement this time. ECB also plans to reduce its balance sheet starting second half of 2024 by gradually decreasing (EUR7.5bil per month) the replacement of maturing securities under the Pandemic Emergency Purchase Programme (PEPP) before discontinuing it completely at the end of 2024.
  • Lagarde’s speech hints peak in policy rates as quoted “Between hikes and cuts, there is a plateau of hold.” but she added that ECB “did not discuss rate cuts” in contrast to Fed chair Powell who indicated that rate cut discussions were beginning.
  • ECB revises headline inflation lower and expects subdued growth in the near term. Headline inflation forecast for 2024 was revised lower from September’s projections at 2.7% and expected to approach ECB’s 2% target in 2025. Growth will be muted at 0.8% in 2024 before recovering to 1.5% for both 2025 & 2026.

Opus View

  • End of rate hike cycle. We view the latest pause in interest rates from the Fed, ECB and BOE as an endorsement of the end of the rate hike cycle. The narrative going forward will be on when central banks will pivot and start normalizing interest rates. The market is already pricing the first 25 bps rate cut as early as 1Q24.
  • Narrative of rate cuts supportive of bond market. While the timing and the quantum of rate cuts in 2024 is still debatable and data dependent, the narrative of rate cuts commencing is supportive of the bond market. The local Malaysian Government Securities (MGS) market will also benefit from this narrative even though we expect the Overnight Policy Rate (OPR) set by Bank Negara Malaysia (BNM) to remain at 3% in 2024.

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