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Neither too hot nor too cold, but precarious

Picture of François Christen

François Christen

Chief Economist

Wall Street's enthusiasm following the publication of satisfactory inflation figures is overdone.

Plagued by the US employment report published on 10 January, the bond markets recovered on the back of inflation figures that were only slightly better than expected. The yield on the US T-Note thus fell from 4.8% to around 4.6%, generating a strong renewed appetite for risky assets. The concomitant decline in equities and bonds gave way to a coincident rebound in both asset classes. It is true that Wall Street’s recovery is not solely attributable to the fall in yields, but also to the strong earnings reports released by major US banks.

Eagerly awaited, the consumer price index published last Wednesday was greeted with euphoria, bordering on irrational exuberance, to use Robert Shiller’s words. Inflation in December (0.4% month-on-month, 2.9% year-on-year) was in line with expectations. Excluding energy and food, however, ‘’core‘’ inflation turned out to be a little softer than expected (0.2% monthly, 3.2% year-on-year, after 3.3% in November). No reason to pop the champagne, but these figures triggered a sharp decline in yields and a surge in indices. Wall Street’s enthusiasm was validated by Fed Governor Christopher Waller, who described the figures as ‘very good’ and hinted that further statistics of this kind could lead to an interest rate cut before the summer. The hawk appointed by Donald Trump has thus morphed into a dove.

The other indicators published last week were positive, neither too cold nor too hot. Retail sales rose moderately, manufacturing output strengthened and the NAHB index showed a slight improvement in conditions on the housing market despite the rise in interest rates. Aggregating multiple statistics, the Atlanta Fed’s GDPnow indicator puts real GDP growth for the fourth quarter at 3%. In the same vein, the IMF has revised upwards its growth forecasts for the USA in 2025 from 2.2% to 2.7% (following an estimated expansion of 2.8% in 2024). The optimism on Wall Street is therefore not without macroeconomic foundation, despite the symptoms of complacency aroused by Donald Trump’s return to the White House. When the Republican takes office on Monday, he is expected to make a number of swift decisions, in the form of executive orders, on energy and immigration.

As is often the case, the European markets followed the trend set by the USA. The yield on the 10-year German Bund fell by around ten basis points to around 2.5%. German GDP contracted by 0.2% in 2024, the second consecutive contraction, and the outlook for the year ahead is gloomy. The IMF forecasts growth of 0.3% for Germany and 1% for the eurozone.

Recent statements by ECB chief economist Philip Lane point to further interest rate cuts, without pause or haste. With four deposit rate cuts expected in the first half of the year, the ‘consensus’ agrees with this view, which should take money market rates to around 2% by early summer. In the UK, sterling yields are down by almost 20 basis points. The downturn in retail sales and the moderation in inflation seen in December could prompt the Bank of England to cut its base rate to 4.5% at the next MPC meeting on 5 February.

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