For the developed Western economies, this Spring coincided with a phase of unexpected economic stability, which also caught the monetary authorities off guard.
In fact, the main reason for the bullish phase that began on the stock markets starting last October was the next cut in key rates. Both the FED and the ECB had then expressed their opinion for several reductions of a quarter of a point in the key rate starting in Spring, but to date nothing has been decided. In fact, this wait-and-see choice is more than understandable given that the inflation rate is decreasing more slowly than assumed and GDP growth, if we exclude the USA where it remains very strong, although modest remains in positive territory, as evidenced by the plus 0,2% of the German economy in the first quarter.
Therefore, to date the ECB still appears to be oriented towards making three reductions of a quarter of a point in the key rate starting from June, but this eventuality appears to be taken with the benefit of doubt in light of what is happening in the USA. Last autumn the FED seemed inclined to cut the federal funds rate 5 – 6 times while today some authoritative insiders even doubt that the central bank will reduce the key rate at all this year. With GDP growing by 3.4% in the last quarter of 2023 and by a preliminary 1.6% in the first quarter of 2024, the conditions to proceed with a reduction in the cost of money are lacking. The main factor supporting the economic situation is represented by the fiscal policy which remained extremely accommodating even after the pandemic period, which in an election year like 2024, with the presidential elections in the USA and the European elections in the EU, is unlikely to be changed. Considering the short-term stock market trend, it has held up very well to this unexpected development of monetary policy, except for the modest correction in mid-April, which still respected the closest technical support level, at the 5000 level for the S&P 500 index.
This is not surprising, as experience teaches us that the best periods for investing in equities are economic recessions and phases of economic stagnation like the current one, at least in Europe and also in China, because the monetary authorities and governments have no alternative but to stimulate economic activity. Regardless of the level of interest rates, which in any case have less relevance on economic dynamics given the preponderance of services in the components of GDP; what is important for the stability of the securities markets is the level of liquidity of the credit systems and the total balance sheets of central banks. The FED has just given a clear signal regarding the creation of monetary inflation, reducing the monthly liquidity drain through securities operations from 60 to 25 billion, and also engaging expansively through reverse repo operations.
These measures are also linked to the liquidity needs of the domestic banking sector where approximately 500 billion need to be injected by the end of the year, so as not to see a repeat of what transpired in March 2023. Currently, the Chinese and Japanese central banks cannot provide a significant contribution to monetary easing, struggling, as they are, with supporting the external parity of their currencies. Therefore, the Chinese economy, despite the government’s commitment, is struggling to recover, significantly contributing to the expected economic stagnation scenario. However, even if the FED were to announce only a modest cut in the key rate in September, more to give a sop to President Biden than out of real necessity, the possible immediate market perception of this eventuality would only result in another modest correction towards the technical support levels, as the underlying trend of the stock markets will remain supported by the expectations of a phase of monetary inflation that could last until mid-2025.
Nicola Bravetti Data Source: Bloomberg
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