what to expect on rates and QT

After the ECB’s stalemate on rates, the spotlight returns to Federal Reservewhich is preparing to announce the monetary policy decisions. No decisions on rates are expected, which will remain unchanged for now and, similarly to the ECB, the Board’s decisions are expected to be anchored to the data released in the coming months.

The Fed’s about-face

Meanwhile, analysts at Pictet Asset management, they remember that “there is a key event which determines the current view: the about-face of the American central bank, which occurred at the FOMC meeting last December 13, when the Fed signaled with its dot plot three rate cuts of 25 points basis each during 2024 (compared to a cut indicated in the September FOMC). The market prices six today, having already begun the recovery in the face of encouraging macroeconomic data relating to inflation.”

Markets still too “euphoric”

“We are in a position to be able to take care of the risks (downside) for growth and not only those (upside) for inflation“, Powell said in the press conference at the end of the mid-December meeting, anticipating a return of monetary policy to the dual target of inflation and growth.

“The US central bank is returned to dual mandate (monetary stability and full employment) with a dramatic coup at the end of 2023, which triggered a rally in the short-term part of the curve”, underlines Pictet AM, adding “on these deadlines the pricing is still euphoric (with 6 denominations built in) medium to long maturities of Treasuries offer more value. On the balance sheet front, the QT is compensated by the shift of monetary masses to liquidity products: further good news.”

Furthermore, Pictet AM believes “the market is more correctly priced with respect to the trend of inflation given the levels to which it has returned today. In addition, by applying the Taylor rule to the consensus projections for inflation (Core PCE) and those for unemployment, the current situation would justify even lower rates of the current ones. For example, the Fed Funds estimated with the Taylor rule would be at 4.63% today to go down to 3% at the end of 2024“.

What to expect for 2024

“2024 will be the year when look for value on the long side of the interest rate curve, especially in the USA. – explain the analysts – Europe is on average expensive but, if you have to choose, short maturities are better”.

“On the bond front we can observe a rather homogeneous trend of the curve of rates of return, although short maturities depend mainly on monetary policies, while medium and medium maturities long term are influenced by market mechanisms less reactive to interest rate movements. Overall, in the last quarter there was a uniform movement of the same size across the entire curve, with a drop of 75 basis points, equal to 1% from the peak; a movement, therefore, particularly relevant.”

“In light of the FED’s reversal of course, and considering that the market has already priced in six cuts instead of the three promised”, Pictet analysts believe that “the short part of the American curve does not offer much value (barring an imminent recession) and may be susceptible to corrections.” “On the other hand, we instead see value on the long side – they add – whose fair value we estimate to be around 3.5%, achievable between now and the end of 2024; value composed of 0.5-1% neutral rate, 2-2.5% inflation and 0.5% Term Premium”.

What will happen to the QT?

For Pictet AM “it is now possible that, as can be read from the December FOMC minutes, a rQT induction“, as also confirmed by the President of the Dallas Fed Lorie Logan at the beginning of January, taking into consideration “the possible negative implications on the circulation of liquidity once the cushion of MMFs invested in RRP has been exhausted. This bearing today amounts to $700 billion in reverse repos and Logan’s suggestion is slow down its erosionto give the financial system time to better adapt to a liquidity regime that is no longer abundant”.