No rates cuts in 2024? Why investors should think about the ‘unthinkable’

One major Wall Street bank is weighing in on what it calls “an extreme scenario” in which no Group of 10 central bank cuts interest rates this year due to sticky inflation, strong economic growth or fresh shocks that push price gains higher.

In a note on Tuesday, Athanasios Vamvakidis, a U.K.-based FX strategist at Bank of America
BAC,
-2.07%,
said it’s worth considering the implication of a seemingly “unrealistic” scenario in which major central banks stay on hold.

For now, markets are pricing in about six interest-rate cuts from the Federal Reserve and the European Central Bank, starting, respectively, in March and April; five cuts by the Bank of England; and two cuts by the Reserve Bank of Australia. B. of A. foresees fewer cuts for all of them because of persistent inflation, resilient economies, and “stretched” labor markets, the strategist said.

Adding some credence to B. of A.’s views were comments from policymakers in the U.S. and overseas. European Central Bank governing council members Robert Holzmann and François Villeroy de Galhau attempted to cool the market’s rate-cut hopes on Monday and Tuesday. Fed Gov. Christopher Waller also said there is no need to be “rushed” with rate cuts. Their remarks helped drive a selloff in the U.S. bond market that pushed the 10-year yield
BX:TMUBMUSD10Y
up 11.5 basis points to 4.064%, and had fed funds traders pulling back slightly on the extent of rate cuts they envision by December.

“The most important discussion in the market as the new year has started is not if, but when and how fast G-10 central banks will start to cut policy rates,” Vamvakidis said. “Even if a scenario of central banks staying on hold this year may seem completely unrealistic to the consensus, it is still worth considering its market implications in our view, as we are puzzled by the aggressive market pricing of rate cuts this year.”

In B. of A.’s year-ahead discussions with investors, “nobody has considered a scenario in which no central bank cuts rates this year,” the strategist wrote in Tuesday’s note titled “Thinking the unthinkable.” He said an “extreme scenario in which no G-10 central bank cuts rates this year” would likely be positive for the dollar, euro, and Swiss franc versus the Norwegian krone, Australian dollar and Japan’s yen.

Adding to concerns about lingering inflation are two factors right now. One is the developments in the Middle East, where U.S.-led strikes on Yemen’s Houthi rebels had British oil company Shell PLC
SHEL,
-1.00%
suspending shipments through the Red Sea. As traders continued to monitor the events, oil futures
CL00,
-0.76%

CL.1,
-0.76%
initially rose before ending lower on Tuesday.

A second factor is U.S. wage growth, which came in at an unexpectedly strong 0.4% for December and 4.1% on a year-over-year basis, and was described by Brent Schutte, chief investment officer of Milwaukee-based Northwestern Mutual Wealth Management Co., as “the one remaining ember that could reignite inflation.”

Treasury yields finished with their biggest one-day jumps of the month or two on Tuesday. This was the case even though traders of fed-funds futures mostly clung to expectations for at least six quarter-percentage-point rate cuts by December from the Fed, which would drive the main U.S. policy rate target down to 4%, 3.75% or lower. U.S. stocks
DJIA

SPX

COMP
closed lower, while the ICE U.S. Dollar Index
DXY
was up 1%.

The type of U.S. interest-rate cuts currently envisioned by markets are considered to be maintenance moves, designed to keep interest-rate levels from becoming too restrictive as inflation falls.

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