And while European inflation is lower than the US – that is closer to the 2 per cent mark – EU interest rates at 4.5 per cent are not nearly as restrictive as US ones at 5.5 per cent.
When the time for cuts is near, the US Federal Reserve will lead the move, with Europe following, and in terms of UK rates, despite the economic slowdown, the labour market remains tighter and wage inflation is much higher. The UK is more likely to ease rates along with Europe.
Quantitative tightening will end roughly around the time rate cuts begin
Markets care less about rates and more about QT. Central banks, which have reduced their balance sheets aggressively in the past year and a half, have been rather silent about discontinuing the practice.
Given the high level of rate uncertainty, it is difficult to predict the end of QT; however, once rate cuts do happen, they will most likely bring an end to it.
As QT persists, the reserves commercial banks hold with the central bank are dwindling.
Non-borrowed reserves currently stand at $3.5tn (£2.7tn), $500bn above the upper limit of the Fed’s comfort level, which Gavekal estimates to be at 8 to 10 per cent of nominal GDP.
The end of QT should help markets rebound, and possibly even allow a sustainable equity bull market.
Short yields to come down, curve to bull steepen
When rate cuts begin, we expect that short rates will come down faster than long rates, allowing the yield curve to bull steepen (the whole curve comes down, but faster at the shorter end).
There is also a probability of bear steepening (the curve moving up faster at the longer end) in case a financial accident forces central banks to cut rates, rather than the economy moving at its present course.
Yield curve steepening is necessary for the profitability of financial institutions, credit flow and the ability of pension funds to meet their long-term obligations, and thus it is very desirable by central banks. This will probably happen naturally.
Economies will slow down in H1 and begin to recover in later H2. No deep recession
The economic slowdown has been well underway since mid-year 2023. However, at least in the US and possibly in the UK we will not see a deep recession.
The reason is that both countries have been running extended fiscal deficits, exactly to mitigate the worst effects of the slowdown.
As central banks begin to communicate rate cuts nearer the end of 2024, we expect consumption to pick up, and economic activity to rebound.
Manufacturing, which leads economic cycles, has already shown evidence of stabilisation and could begin to recover earlier in the year. The services sector should follow.
2024 and possibly 2025 are still expected to see growth below trend, however, as higher-than-average inflation and high interest payments eat into real economic output.
Inflation to stabilise, bar geopolitical turbulence
Inflation has become de-anchored from its lows in the previous decade and a half, as the pandemic accelerated deglobalisation and various centrifugal forces.
