Central Bank Meetings Overview: Igniting the Chase for Yield

This week saw a series of central bank meetings that delivered a plethora of surprises. In particular, the communication from both the Federal Reserve and the European Central Bank diverged from market consensus expectations. Strong data on the U.S. economy, including service activity indices (PMI), employment and wage growth in November, and changes in unemployment benefit claims in recent weeks, shaped expectations that the Fed would maintain a pause at its Wednesday meeting and initiate a discussion on monetary policy easing only in the first quarter of 2024. Additionally, there were hypotheses that the sharp decline in bond yields (risk-free rates, benchmarks for all other rates in the economy) in October-November would have a "heating" effect on the economy, delaying the onset of central bank rate cuts. However, the Fed didn't hold back; Powell, during the press conference, clearly stated that FOMC members had already begun contemplating and discussing how the rate would decrease in 2024. This became the first major surprise for the market. The updated central bank economic forecasts also worked against the dollar: Core PCE for 2023 and 2024 were revised downward compared to September, while real output increased for 2024. This provided an additional stimulus for market participants to increase demand for risk assets.The second surprise was the signal of resistance from the ECB to market expectations of an aggressive easing of credit conditions in 2024. Although the European Central Bank left the main policy parameters unchanged yesterday, Lagarde's statement at the press conference that the members of the Governing Council had not discussed rate cuts at all was a surprise.The element of surprise here was that incoming data on the European economy for October-November seemed to indicate a much more significant slowing impulse than in the U.S. For example, core inflation sharply slowed from 4.2% in October to 3.6% in November (forecast at 3.9%), and GDP contracted by 0.1% in the third quarter. Considering that the ECB's sole mandate is to maintain price stability (inflation targeting), the fact that the sharp decline in inflation in November did not prompt a change in rhetoric became an additional argument in favor of the strengthening of the Euro yesterday. One tangible result of the sharp shift in market expectations after the meetings of the two leading central banks was the decline in the spread of short-term bond yields between the U.S. and the EU by more than 20 basis points over the last two days:The pound sterling strengthened on Wednesday and Thursday by more than two percent after the Fed signaled a softer stance on rates ahead, while the Bank of England, at Thursday's meeting, emphasized that inflation risks persisted, so ruling out further rate hikes was not possible. Three officials out of nine advocated for a rate hike on Thursday, which was also a rather hawkish signal for the market (especially against the backdrop of the Fed decision). Both the bond market and interest rate derivatives revised their expectations for central bank policy easing in 2024 by approximately 7-10 basis points. This was enough to attract investors to British fixed-income assets, triggering an upward movement in GBP:A highly successful combination for risk assets, particularly the U.S. stock market, was the combination of the Fed’s dovish signal and strong U.S. reports on Thursday. Retail sales in October grew by 0.3% for the month, beating the forecast of -0.1%, and initial jobless claims sharply fell again, to 202K against a forecast of 220K. The data unequivocally increase risk appetite in the market, and the prospect that this will be compounded by a chase for yield (i.e., speculative momentum) shifts short-term risks for the U.S. market towards further growth, at least until the end of the year.