Guest post by Gabor Steinart: No interest rate cuts! The ECB will disappoint investors and property buyers

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I rejoiced too soon: The hope that interest rates will soon be cut is driving stock markets to highs and making families dream of owning an affordable home. The euphoria is exaggerated. Four things indicate that the ECB is cutting interest rates later and weaker than expected.

The world's investors need fresh money like fish need water. Central bankers are the gatekeepers who use their interest rates to regulate the water level in the pond of the global economy, while ensuring the entry and exit of the money supply.

If interest rates and therefore borrowing costs are high, fresh money flows only sparingly into circulation. If interest rates are low, investors have easy access to money. Then you will be swimming in liquidity.

As the central bank of the largest economy, the Federal Reserve, based in Washington, has the most powerful fiscal instrument in its hands. It has real power to set prices relative to money. In a world where 60 percent of trade in goods is settled in US dollars, its interest rates are a kind of reserve currency that also serves as a guide in Tokyo, London and Frankfurt.

The entry stopped: From May 2022 to July 2023, the US Federal Reserve increased the interest rate in eleven steps, from 0.25 to 5.50 percentage points, due to the sharp rise in inflation. The ECB did the same for the eurozone with a delay. The sudden devaluation of money had prompted the lock keepers to act.

The lock remains closed for the moment: In January, the Goldman Sachs analyst wrote Joshua Schiffrin Although he assumes there will be four interest rate cuts by the Fed in 2024. But the man was an optimist, not a realist. Maybe he was just a well-paid dreamer.

The hope The expectation of a quick and then gradual cut in interest rates is diminishing. Currently no one believes in a rate cut in May. And according to the CME FedWatch tool, only 16 percent of market participants expect this could happen in June. The inflation rate rose again in March from 3.2 to 3.5 percent, a bitter setback.

This week, the ECB left the key interest rate unchanged as a precautionary measure. He did not indicate whether in June he would reduce it and thereby open the money floodgates again, as the markets wanted. Because we at the ECB Tower know that there are four reasons why the Federal Reserve is likely to maintain its tight monetary policy for longer than previously assumed:

1. Inflation is more persistent than expected

Not everything is clear: The current inflation of 3.5 percent has persisted for nine agonizingly long months: the US inflation rate has been stuck just above this level since June 2023. This, in turn, means that food prices They have increased by around 10.5 percent cumulatively since this monetary devaluation began in 2022.

Unlikely relaxation: A look at oil prices, which have risen again since December, suggests that gasoline and fuel are becoming more expensive. OPEC is doing everything it can to reduce oil production to keep prices high.

Electricity is also five percent more expensive than a year ago. Rents are increasing significantly, up 5.7 percent year-on-year. All in all, life in the United States and Europe has become an expensive diversion.

Christopher Waller Therefore, , a member of the Board of Governors of the Federal Reserve, is not yet willing to open the floodgates: “The latest data shows me that it is prudent to keep the interest rate on its current restrictive path possibly for longer than was previously assumed.”

2. The labor market also works without cheap money

The second objective of the Federal Reserve: In addition to price stability, its objective is to maintain maximum employment. Currently, the labor market does not indicate that there is an urgent need for a policy change by the central bank.

  • Low unemployment: The unemployment rate is 3.8 percent, which corresponds to almost full employment.
  • The job engine runs smoothly: In March, 303,000 new non-agricultural jobs were created. Only 200,000 were expected.
  • Salary increases above the inflation rate: Wages rose 4.1 percent in March compared to the same month last year. This means that there is still pressure in the boiler.

This eliminates a central argument of recent months, when a weak labor market and, therefore, a monetary policy stimulus was expected. Any stimulation in this situation could even cause overheating.

3. The strong economy

Even without the Federal Reserve opening the floodgates, the American economy is running smoothly. There is currently no need for additional economic stimulus.

Last year, US GDP grew 3.1 percent. This year, economists expect the numbers to rise by two percent. The United States appears to be achieving a “soft landing,” that is, avoiding a recession despite rising interest rates.

Stock Bull Market: The US S&P 500 stock index gained approximately 25 percent in value over the past twelve months. For the MSCI World stock index it is almost 21 percent. Germany's leading Dax index is still up around 15 percent, driven less by the sluggish German economy than by the high level of liquidity on Wall Street. The majority of DAX shareholders are not from Germany.

4. Public debt increases inflationary pressure

The restrictive monetary policy of the central banks in Washington and Frankfurt is offset by the government's expansionary budget policy. Although central banks have cut the money supply, finance ministers have used their budget flexibility to increase the money supply. Especially the United States, but also France and Italy, are expanding their budgets.

In 2023, the US national debt increased by a total of $2.65 trillion so far 34 billion US dollars. But also in France and Italy people no longer feel bound by any stability agreement.

Extra money in the business cycle does not fight inflation, it fuels it. Professor Thomas Mayer economist and director of the Flossbach von Storch Research Institute, writes in a recently published study: “The fiscal theory of price levels suggests that a persistently high net public debt will trigger constant inflationary pressure.”

Jaime Dimon , the head of JP Morgan, thinks and speaks the same way: The three big drivers of the national debt – the war with Russia, the tense military situation in the Middle East and ecological restructuring – are also important drivers of the devaluation of the currency. In a letter to the bank's shareholders he writes: “The enormous fiscal spending, the trillions needed each year for the green economy, the remilitarization of the world and the restructuring of global trade, all this has an inflationary effect.”

Therefore, the director of the largest bank in the world does not expect a rapid reduction in money prices, but rather medium-term interest rates of between two and eight percent.

He advises all investors to be wary of the desire for a change in interest rate trends and to protect their investments against a latent increase in interest rates.

Conclusion: The money guardians in Frankfurt, London and Washington do not want to make any mistakes in this complex situation. They fear that cutting interest rates too quickly will boost inflation and possibly even overheat stock markets.

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