Central banks in Washington and Frankfurt face critical decisions as inflation data shapes monetary policy. With U.S. November inflation at 2.7% year-over-year and the Fed eyeing a potential rate cut, market expectations have shifted dramatically. Meanwhile, the ECB contemplates its own rate strategy as the Eurozone edges closer to its inflation target amid economic challenges.
Fed Rate Cut Odds Surge to 98.6% After November Inflation Figures
Following the release of November inflation data that met expectations, traders have increased their bets on a quarter-point rate cut at next week's Federal Reserve meeting. However, the report, which highlighted persistent price pressures, provided additional evidence that progress toward the Fed's 2% inflation target has stalled.
A report released yesterday by the U.S. Bureau of Labor Statistics showed that headline inflation in the U.S. rose 0.3% in November compared to the previous month and 2.7% year-over-year. The core index, which excludes volatile food and energy costs, increased by 0.3% for the fourth consecutive month, maintaining a 3.3% annual gain.
The shelter index, one of the stickiest components of inflation, slowed from prior months but still rose 0.3% in November, accounting for nearly 40% of the overall monthly increase. Meanwhile, the food index rose 0.4%, and the energy index, unchanged in October, increased 0.2% over the month. Year-over-year, the food index was up 2.4%, while the energy index declined by 3.2%.
While price pressures in the U.S. have eased significantly from their pandemic-era peaks, the latest data suggests that the path toward the inflation target has stalled. On the flip side, following the Federal Reserve officials' strong start to the easing cycle in September, aimed at preventing further cooling of the labor market, recent data has indicated that the labor market is not cooling as quickly as feared. As a result, at this stage, the risks to the Fed's dual mandate appear to be roughly balanced.
However, considering both the latest data and the policies expected to be implemented by Donald Trump, concerns about inflation have taken a step forward. Nevertheless, this situation does not yet necessitate the Fed pausing its rate cuts at next week's meeting.
Breaking down the November inflation report, Citigroup Inc. economists argued that the slowdown in the shelter index justifies a quarter-point cut at next week's meeting. Additionally, even the labor market remains robust, the recent uptick in the unemployment rate is also seen as supporting this decision.
According to swap market data, traders are pricing in a 98.6% probability that Fed officials will deliver a 25-basis-point cut on December 18. This is up from the pre-inflation data level of 86%, signaling that market participants now view the cut as a near certainty.
On the other hand, concerns over higher inflation are expected to lead the Fed to adopt a more cautious approach to rate cuts next year. At next week's meeting, the Fed will also release its 2025 projections, providing further insight into the likely policy path.
If policymakers leave their September projections unchanged, it would signal plans for four more quarter-point cuts in 2025. However, many economists expect that growing inflation concerns will lead to fewer cuts than previously planned. Similarly, swap traders anticipate no more than two or three cuts next year.
While these expectations will become clearer with the Fed's decision next week, rising confidence in slower rate cuts has supported the U.S. dollar's strength. Even so, traders are now focusing on weekly jobless claims and producer price data due later today. The Producer Price Index, particularly its components included in the Fed's preferred Personal Consumption Expenditures Price Index, will be closely analyzed.
Eurozone's Rate Game: Gradual Cuts or a Bold Leap?
The European Central Bank (ECB) is preparing to cut interest rates for the fourth time, following inflation nearing the 2% target and continued contraction in economic activity.
According to a Bloomberg survey, all but one economist predict that ECB policymakers will implement another quarter-point reduction, bringing down the deposit facility rate to 3%. Only economists from JPMorgan Chase foresee a larger half-point cut, citing recent data indicating weak growth and inflation.
When ECB officials meet today, they will assess the region's economic outlook. Additionally, they will need to evaluate how Donald Trump's economic policies might impact Eurozone and consider political risks in Germany and France.
Judging by their statements so far, officials appear to favor a gradual approach. However, as in the October meeting, they will debate whether a significant half-point move is necessary. While traders do not anticipate such a bold step at today's meeting, the possibility remains on the table for future sessions.
Projections for 2025, to be released alongside the decision, are expected to shed more light on these expectations. Markets will also closely follow remarks from ECB President Christine Lagarde after the meeting.
Expectations for faster rate cuts could increase pressure on the euro, the region's common currency. With the widening interest rate gap in mind, the US dollar is likely to strengthen further against its major rival.
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