The US economy’s landing comes into focus, as we wait for ECB

As we lead up to these key events on Thursday, European stock futures are a sea of red and are falling after strong gains on Wednesday. Futures are still pointing to a positive open for US stocks. In Asia, Chinese stimulus measures have helped the Hang Seng and the main Chinese on shore index continue to extend gains. The Hang Seng is up by more than 5% this week. Sentiment has remained upbeat as move towards the end of January, and even with the declines on Thursday morning, European stock markets are also stronger this week. The Eurostoxx 50 index is higher by 3.64% in the last week. Will today’s ECB meeting help or hinder this rally as we move towards the end of the week?

The ECB will announce its interest rate decision at 1315 GMT, followed by Christine Lagarde’s press conference at 1345 GMT. The market expects no change in interest rates, but they do expect a decent steer on when interest rates will be cut. The market is currently pricing in the first rate cut for April, with just over 5 cuts currently priced in for the whole of 2024. The market currently expects the ECB’s main interest rate to fall to 2.59% by year end.

Will the ECB point to a summer rate cut?

The ECB is in the middle of the central bank pack when it comes to rate cut expectations. The market is currently pricing in just under 4 rate cuts for the UK, and nearly 6 rate cuts for the US. These expectations can move around, so Lagarde’s comments and the ECB statement will be heavily scrutinized to see if their predictions for rate cuts are correct. In an interview with Bloomberg just over a week ago, the ECB President said that rate a cut in the summer is likely, however, she caveated this remark by saying it would depend on the economic data.

We expect the ECB President to acknowledge the fact that the economy is weakening yet wage growth remains high and inflationary. For example, the latest wage growth in Germany was 7.3% for Q3, much higher than the ECB’s 2% target inflation rate. The ECB must wrestle with this tension in the coming months as it decides on monetary policy.

Will the ECB stage a Fed-like pivot?

At today’s meeting, the market will be looking to see if the ECB does a Fed-style dovish pivot and moves to an explicit easing bias. Lagarde seemed to do this last week in Davos, will she stick to the same message today? If she does, then this is likely to be the biggest theme for European asset prices for the medium term, and it could trigger an extension of the recent rally after a mixed start for stocks in the currency bloc at the start of this year. The euro has generally strengthened this week, although it has lost a bit of steam ahead of this meeting. $1.0932 was the high on Thursday, and a less dovish message from Lagarde could see EUR/USD punch through the $1.10 level.

US GDP – is there a risk of an upside surprise?

Elsewhere, US data will also be in focus on Thursday. The type of landing the US economy will have could become clearer on Thursday as we wait for US Q4 GDP. The market is expecting the Q4 YoY growth rate to fall to 2% from 4.9% in Q3. Personal consumption, a key driver of US growth, is expected to moderate to 2.5% from 3.1%. These are growth rates that Europe and the UK would die for, yet it is a significant slowdown from Q3’s rapid pace of growth. The Atlanta Fed GDP tracker GDPNow is estimating a higher rate of GDP growth for Q4, at 2.4%, so the bias could be to the upside.

While GDP reports are backward looking data, this report is important for the potential timing of Fed rate cuts. The market has scaled back expectations for a March interest rate cut from the Fed, and the probability of a March rate cut is now only 42%. The market now thinks that the first rate cut from the Fed will come in May, and by year end US interest rates could be just below 4%.

Has the US economy already had its soft landing?

Thursday’s data might suggest that the US economy has already had its soft landing – the sharp moderation in growth between Q3 and Q4. It also needs to be seen alongside more timely economic indicators. The PMI reports for the US were weaker than expected, although the service sector survey increased vs. December. Added to this, initial jobless claims fell below 200k last week, suggesting that there is still strength in the US labour market, even with the moderation in economic growth.

Key risks to the US economy

There are two risks for the US economy right now. Firstly, the risk of the economy overheating, because the Fed cuts too early and the labour market is still too strong. Secondly, a longer lag in monetary policy, which means if the Fed holds off on cutting rates in the coming months, then it could plunge the US economy into a steeper decline, which is also something the Fed will want to avoid. Thus, the Fed must walk a tightrope in the coming months, and today’s data could give us an indication of which track the US economy will take from here.