Markets are pricing in five interest rate cuts in the US by October 2024. The decisions of the Federal Reserve (Fed) will affect currency markets, the Polish złoty, cryptocurrencies, and the price of gold.
Are investors being overly optimistic, especially given that the fight against inflation has not yet ended with a clear victory for the Fed?
“Over the past few years the Fed has accustomed investors to a rather loose monetary policy, favoring low interest rates. Over twenty years, we’ve had very short episodes of interest rates even close to those we have now, hence the market eagerly predicts that the Fed will prefer rate cuts at the first opportunity,” says Dr. Przemysław Kwiecień, Chief Economist at XTB, in an interview with MarketNews24. “The market exerts pressure which the Fed resists, claiming that it’s too soon to talk about rate cuts.”
However, markets see that although inflation is above the targets of major central banks, it is much lower than just a few months ago. There are many reasons to judge that the fight against inflation is going well and is not dominated by base effects or year-on-year comparisons.
Markets are waiting for more data to confirm that rate cuts will begin sooner. Incoming data are not clear and the focus is especially on the labor market, which has been very strong and consumer demand may have been stimulating weakening inflation. Investors are waiting for a weakening of the labor market and the latest data from the US, published in early December, have been disappointing. The October Job Openings and Labor Turnover (JOLTs) figure was 8.733 million, compared to a forecast of 9.3 million and 9.55 million previously.
The data suggest a faster labor market cooling than anticipated. It’s possible that if future labor market readings show a similar trend, the market will start pricing in a recession with higher probability, and high interest rates do have their cost. Wall Street thus interprets the data as the ‘icing on the cake’ for the dovish assumption of 125 basis points of Fed cuts in 2024. Hence the ‘bad news is good news’ narrative is still working. This is because, although the JOLTs disappointed, the number of available jobs remains extremely high, which is positive for the economy and the fight against inflation.
Lower interest rates mean, in theory, a weaker dollar. These lower rates harm the dollar, especially being the reserve currency, and favor emerging market currencies, as they increase investors’ interest in riskier assets.
However, in Europe too there are expectations of interest rate cuts at the hands of the ECB. But it may turn out that economic data are worse than in the US and the ECB finds itself under greater pressure to loosen its policy. The changes in the EUR/USD pair can go in various directions, and the złoty usually strengthens alongside a stronger Euro.
“The złoty is no longer a cheap currency. It’s important to remember that it has already gained significantly, since in the autumn of 2022 we had dollar at 5 zł,” comments an expert at XTB. “At one point the dollar was below 4 zł, and the Euro depreciated from 5 zł to levels of 4.30 zł, so a significant movement has already been made. Hopes related to the results of the parliamentary elections in Poland and the growing chances in the CPP have also been priced in.”
After the parliamentary elections, the NBP also changed its stance. In December, as expected, it left interest rates unchanged. This time there were no surprises, so the market reaction was basically limited. The złoty benefited in recent weeks from the change in stance of the central bank, although it can be seen that this force is slowly being exhausted. The communication after the decision did not reveal many changes, suggesting that the current level of interest rates will be maintained for at least a few more months.
“I do not see any fundamental basis for further appreciation of the złoty, especially as inflation in Poland looks worse than in the Eurozone and I don’t see any prospects for reaching the inflation target,” says P. Kwiecień from XTB. “However, market trends may diverge from what economists think. Sentiment can change from extremely optimistic to extremely pessimistic.”
Rising global optimism favors cryptocurrencies. There is a high chance of the launch of ETFs on Bitcoin first. American government control over cryptocurrencies is also increasing. The market is already discounting the future, hence cryptocurrency prices are rapidly rising.
The price of gold set a historical record, reaching USD 2,146 per ounce in futures contracts. Gold prices are also benefiting from expectations for lower interest rates. Lower rates mean a lower alternative cost of holding gold, which “does not pay dividends”. Capital is again flowing into gold.
