(BFM Bourse) – The CAC 40 has seen a spectacular rise in recent weeks, as investors ruminate on future rate cuts from major central banks. But have they put the cart before the horse?
The sequence gave rise to numerous “memes” on social networks. In early December, the Chairman of the American Federal Reserve (Fed), Jerome Powell, gave a speech in which he affirmed that it was premature to speculate on cuts in key rates, adding that these same rates were “high to last “. So many warnings that the markets have brushed aside. Internet users then mocked the lack of impact of the central banker’s words, mocking the non-reaction of investors, particularly on the social network X.
This episode clearly illustrates the questions surrounding the recent rally experienced by the markets, with the underlying fear of a potential excess of optimism regarding monetary policy expectations.
The DAX has already pushed back its all-time highs, and the CAC 40 is on track to break its records this Monday, as has already been accomplished by the CAC 40 GR, the index which assumes that dividends are reinvested. Since the end of October, the CAC 40 has gained more than 500 points, or almost 11%.
This upward movement therefore finds its origins in the clear deceleration of inflation which has fueled market speculation on key rate cuts by the major central banks next year.
“In recent weeks, big changes in tone have been observed among ‘hawkish’ members (who advocate a restrictive monetary policy) with accommodating statements. At the ECB, Isabel Schnabel said she was surprised by the extent of the decline of inflation and even quoted Keynes “when facts change, I change my mind”. On the side of the Fed, Christopher Waller, a heavyweight who campaigned for significant rate increases in 2022 and 2023, spoke of rate cuts, not to save the economy but because monetary policy rules, such as the Taylor rule, which is used as a tool by central banks, would impose it,” explains Bastien Drut of CPR AM.
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Ambitious expectations?
However, hasn’t the market been too quick to do so? Currently, according to the CME Group’s FedWatch tool, investors are counting on key rate cuts from the US Federal Reserve ranging from 100 to 125 basis points next year, or 1% to 1.25%. And for the ECB, expectations seem even greater. For example, Deutsche Bank changed its forecast, expecting 150 basis points of declines in 2024, compared to 100 basis points previously.
“Market expectations are ambitious,” judges Alexandre Baradez, head of market analyst at IG France, “because core inflation (excluding energy and food prices, Editor’s note) still remains at 4% in the States. -United States and inflation in the euro zone is at 3.6%. “I have the impression that the market is focusing a lot on the fall in rates but avoiding the “higher for longer” phase, that is to say a plateau in terms of key rate levels, a stationary period which helps reduce inflation,” he continues.
Two elements lead him to doubt the optimism of the market: the stability of the price component of the latest ISM services index in the United States and the relative good performance of the latest American employment report.
“If the markets were to further anticipate key rate cuts from the major central banks of a more significant magnitude than at present, this would become excessive,” judges Bastien Drut for his part.
“However, it seems abnormal that the market is pricing in more rate cuts at the ECB level than at the Fed. The ECB has a less fluid process than the Fed, with more central bankers voting at monetary policy meetings and a consensus more difficult to establish. In addition, it was late compared to the Fed in its cycle of rate increases and inflation was higher in the euro zone, which therefore requires higher rates for longer”, develops the market economist.
A potential drop of 10% in Europe?
Last week, the Financial Times published a survey in which the daily questioned 40 “academic” economists (i.e. working in universities). Result: two-thirds of them anticipate that the Fed will not lower its rates before the third quarter, and three-quarters estimate that this reduction will be less than or equal to 50 basis points. This therefore contrasts significantly with market expectations, with a first drop expected in May and cumulative reductions of 100 to 125 basis points, on the part of investors.
Another legitimate question: if the market focuses above all on monetary policy, are the risks of recession not currently underestimated by investors?
“The theme of economic slowdown is currently buoyant for the market but there would be legitimacy for it to focus more on economic risks and company results which could then be challenged. Above all, investors could under -estimate the fact that the Fed would be ready to accept a greater economic slowdown than they anticipate, before reducing its rates”, considers Alexandre Baradez.
“At first, the equity markets welcome the fall in long-term rates and are in a perspective where ‘bad news is good news’, with bad economic news leading to increases in equities. But there is a risk that the we come back to “bad news is bad news”, with bad news which leads to falls in stocks, even if it is difficult to know when the change will take place. We are not there yet”, develops for his part Bastien Drut.
Bank of America strategists are in any case cautious for the future on European markets. In a note published at the end of November, these experts fear that the global economy will weaken next year and thus put pressure on company earnings per share. They say the pan-European Stoxx Europe 600 index could fall to 390 in mid-2024 before rising to 420 at the end of next year. Which would represent a drop of more than 11% over one year…
Julien Marion – ©2023 BFM Bourse