Central Bank Policy Pivots Come into View for 2024

While the ECB was first out the gate to acknowledge the likely peak of the hiking cycle, the Fed is now leading the charge to bring rate cuts into view. What was supposed to be a relatively tame limp into year-end for central banks became much more exciting as the Federal Reserve doubled-down on the dovish tone of the FOMC statement. We've subsequently pulled forward our forecast for the first fed funds rate cut from June to May.

Other central banks, especially the ECB and now the BoC, are more clearly signalling peak rates. The BoE has yet to shift gears, and there are still risks of another RBA hike. The steady decline in the 3-month rate of core inflation is reassuring central bankers that their job is done.

We have long expected sharp rate cuts from around mid-2024. Market pricing of 2024 rate cuts has moved sharply in recent weeks coming more in line with our views. Compare this with our recent TD Securities 2024 Global Outlook to see a change from what the market anticipated not long ago. Risks to inflation, though, remain two-sided, as we detail in the following section.

Pivot Point?

It was supposed to be a relatively quiet end to the year for central banks, but of course someone had to rock the boat, and when that someone is the Fed, it's hard to ignore. A combination of weaker inflation dynamics coupled with a clear shift on the FOMC's assessment of inflation dynamics have led us to pull forward our expectation of the first fed funds rate cut from June to May 2024. We've also slightly lowered our probability on a U.S. mid-year recession to 60%, but it is still a clear base case as persistently high real rates continue to weigh on the economy.

For the BoE, ECB, and BoJ, they chose the safe route into year-end. The BoE essentially copy and pasted November's policy decision, while the ECB built on its recent communications and essentially ruled out all further hikes. The BoJ nudged closer to a hike in our view, with the statement showing more confidence that the recovery is taking hold. The BoC's recent communications have clearly nudged it closer to rate cuts too. What's clear is that across major economies, core inflation momentum has slowed sharply, giving central bankers the confidence that they've now reached terminal rates.

We've long been in the camp for faster 2024 rate cuts than markets expect, and it does look like markets are starting to catch up with that analysis. Indeed, markets are now looking for more rate cuts from the ECB and BoC than we are now. We think these moves are overdone and maintain that position.

Risks to 2024 Policy

To the downside, there's a compelling risk scenario that sees inflation return to its pre-COVID dynamics. If central banks hold rates too high for too long, G10 inflation may end up heading back below target. The last thing central banks want right now is too-low inflation that necessitates a return to the effective lower bound and potentially QE. It's easy to see them wanting to return to neutral rates as soon as they have confidence that inflation has slowed from its recent highs. This forms a core part of our base case forecasts.

To the upside, there are near- and long-term upside risks to inflation. In the near-term, geopolitical tensions in the Red Sea are affecting the global shipping market, not unlike the 2021 Suez Canal obstruction. This time, the impact might be somewhat lower on consumer prices - the 2021 incident occurred during a period of an incredibly tight global goods market, and high demand coupled with scarcity of consumer goods had a sharp non-linear upward impact on inflation. This episode, while potentially more persistent, is occurring against the backdrop of a more normalised global goods market with greater spare shipping capacity, so it may have less of an impact on CPI. In the longer-term, developments following the U.S. election may lead to higher inflation in 2025; a topic to which we will return in the new year.

Central banks have likely learned some lessons in the last few years, and we expect less forward guidance through this cutting cycle. This "feature" constrained and delayed some key central banks in their hiking cycles, and it's a mistake they're loath to repeat. This means that cuts are likely to be far more data-dependent through this cycle even if the resulting rate path does end up looking like a relatively straight line down to neutral.