Weekly Forecasts 4/2024

Liquidity and peak escalation

Forecasts:

1. The Federal Reserve surprise (mistake) and the PBoC easing have diminished the risk of a market crash for October.

2. While our forecasts continue to indicate a liquidity draining for October, recent actions by the Fed and the PBoC may even turn that into an injection.

3. The scenarios of peak escalation for Europe.

The likely mistake of the Fed and desperation of the PBoC

The Federal Reserve surprised many, including us, by cutting the Fed Funds Rate by 50bps in its FOMC meeting past week. Tuomas did an extensive analysis on the likely reasons behind this “surprise”, and we do dwell into those any further here.

Effectively, the Fed did what markets, and politicians, were expecting. It provided a strong boost for the markets regardless of data pointing to heightened risk of inflation picking up again. The yield of, e.g., U.S. 10-year note has been pushing up ever since, which indicates that the Fed may have made a policy mistake.

Like we noted in the weekly forecasts two weeks ago, there’s a risk of the U.S. economy heading into a stagflation. With the surprise cut, the Fed increased that likelihood, because inflation expectations have not anchored to the 2% annual rate considered as “stable” inflation, and they may now start to rise again. Geopolitical risks to a stable inflation outlook are also massive. This is why it’s difficult to consider the “emergency cut” by the Fed anything else than a mistake.

On Tuesday, Beijing announced a swathe of operations to prop up the financial markets. These included the People’s Bank of China (PBoC) cutting the reserve requirement ratio (cash banks are obliged to hold) by 50bps and cutting the 14-day reverse repo rate by 20bps thus making it cheaper for banks and financial entities to lend from the PBoC. It also promised to conduct other cuts (like to the 7-day reverse repo rate) in the future. There were also cuts to interest rates of existing mortgages and lowering of minimum down payments of all types of homes.

However, because the Chinese economy is so heavily indebted, these are likely to have only a miniscule resuscitating effect. The financial measures did give a boost to the stock market, though.

Liquidity forecasts with updated data