Weekly market wrap

Central banks on the move: Direction clear, speed uncertain

Last week it was the Nasdaq's turn to reach a new milestone, briefly surpassing the 20,000 mark. The winning formula for the stock market this year has been solid economic growth, rising corporate profits, moderating inflation, and the start of central-bank easing. The outlook remains positive, but the improvement in inflation is stalling in the fourth quarter, creating some uncertainty about what comes next for central banks. We share our take on what the latest U.S. CPI (consumer price index) means for the Fed and review the recent moves from the world's major central banks.

November CPI: A mixed bag, but some encouraging news

• No worse than expected - The November CPI was the last key datapoint before this week's Fed meeting, and heading into the release there was some nervousness about the potential for an upside surprise. However, results came right in line with expectations, suggesting that even though the progress in bringing inflation down has slowed, it is not about to reverse in any major way. Core consumer inflation, which excludes the volatile food and energy costs, rose by 0.3%, leaving the annual rate unchanged at 3.3% for the third straight month. This pace of price increases is half of the 6.6% peak in 2022, but still higher than the Fed would like¹.
• Prices of discretionary goods and services accelerated – The headline CPI ticked up to 2.7% from a year ago, the first back-to-back annual acceleration in eight months, partly driven by food and gasoline¹. Outside of those categories, prices of cars, furniture, hotels and airfare increased at a faster pace, likely reflecting the strength in consumer spending that continues unabated (the recent hurricanes also played a role in boosting demand and prices for cars). While we expect inflation to move slightly higher in the next two months based on tougher comparisons from a year ago -- the so-called base effects -- we don't think that would represent a change in the overall trend. Leading indicators, like prices paid by manufacturers and service firms, do not point to a second wave of inflation, but rather some persistence of current readings.

• Good news on housing – Shelter inflation has been one of the most persistent categories of price pressures, making up the bulk of CPI gains this year. However, housing costs rose 0.2%, posting the smallest monthly increase since January 2021¹. This helped the annual rate fall below 5% for the first time in over two-and-a-half years, providing hope that the long-awaited slowdown in housing inflation may be around the corner¹. Based on timely market-based measures for rents and home prices, we think that the disinflationary trend in shelter inflation has more room to go. Given the category's 35% weight in the consumer price index, a housing cooldown can go a long way in helping overall services inflation ease further¹.

Inflation data greenlights December Fed cut, signals caution for 2025

• Steady as she goes - In our view, last week's data will not deter the Fed from lowering its policy rate this week. There were no big surprises in either the consumer or producer price index, while last month's uptick in unemployment was consistent with policymakers' view that the labor market is no longer a source of inflation. The September Fed projections implied two additional cuts this year, one of which was delivered in November, and the bond market is now pricing in a 95% chance of another quarter-point cut in December¹.
• No rush next year – However, as we enter 2025 the Fed will likely slow its pace of easing, as uncertainty around the path of inflation rises. Progress on disinflation has slowed, and potential changes in fiscal, trade and immigration policies may complicate the Fed's effort to reach a neutral rate, a level that’s neither restrictive nor stimulative for the economy. We think the Fed's updated December interest-rate projections (the dot plot) may shift slightly higher, projecting a shallower easing cycle ahead, as both growth and inflation have been stronger than expected since September. We are looking for two or three rate cuts in 2025, with the fed funds rate settling in the 3.5% - 4% range by the end of the year.

Other central banks have reasons to fast-track their way to neutral policy

• Bank of Canada (BoC) leads the way – Last week the BoC lowered its policy rate by half a percentage point to 3.25%, the high end of its 2.25%-3.25% estimate for the neutral rate. Over the past six months the bank has cut rates by 1.75%, faster and deeper than any other advanced economy¹. Unemployment has risen to a two-year high at 6.8%, as population has been rising faster than jobs, core inflation is within the BoC target range, and economic growth in the fourth quarter has been weaker than expected¹, all suggesting that policy no longer needs to be in restrictive territory. However, now that rates are in the neighborhood of neutral, policymakers are signaling that they will downsize the rate cuts and move at a more gradual pace.
• European Central Bank (ECB) acknowledges downside risks – Last week the ECB was another central bank that cut rates, lowering them by a quarter point, as expected. After four rate cuts in this cycle, the bank's policy rate has come down one percentage point, leaving it at 3%. Unlike the U.S., the outlook for growth and inflation are being revised lower, and markets are starting to price in a deep rate-cutting cycle for next year. Also in the region, Switzerland's central bank surprised markets with a 0.5% rate cut, reducing its policy rate from 1.0% to 0.5%, the largest reduction in nearly a decade¹.
• U.S. dollar strength reflects divergent outlooks – With swifter rate cuts abroad, the difference between domestic and international interest rates is providing a boost to the dollar against a basket of other major currencies. From an economic standpoint, this can make imported goods cheaper, helping U.S. inflation moderate. From a portfolio standpoint, international stocks tend to underperform during periods of a strengthening dollar, supporting our view that U.S. stocks are well-positioned to continue to lead.

Entering a more uncertain phase, but the winning formula remains intact

• Direction is clear; speed and depth up for debate - Heading into 2025, it is clear that the direction of travel for interest rates is lower, but the speed and depth of rate cuts is more uncertain. Unlike this year where the Fed and others delivered larger rate cuts, the pace will likely slow, as central banks try to balance cooling but still above-target inflation with a resilient economy and labor market. The Fed does not want to overstay its welcome in restrictive territory, risking an economic slowdown, but at the same time there are no reasons for urgency in normalizing policy.
• Animal spirits awake – After a year of the economy defying expectations for a slowdown and after the U.S. presidential election, investor and CEO confidence is now surging. The NFIB small business optimism index released last week saw the largest month-over-month jump in 30 years on prospects for tax cuts and other pro-growth policies¹. Capital spending that was delayed because of the election uncertainty may materialize in 2025 and beyond, helping manufacturing activity recover and potentially sustaining the strong economic momentum. However, investor sentiment is heating up as well, and as the bar of expectations keeps rising, it leaves potential room for periodic disappointments.
• Backdrop broadly supportive - A shallower rate-cutting cycle suggests that borrowing costs may remain high for longer, putting a lid on how far valuations can rise. But the winning formula's ingredients are still in place. Wages are rising faster than inflation, the economy continues to add jobs at a healthy clip, corporate profit growth is accelerating, and enthusiasm around innovation and artificial intelligence remain alive and well. Historically, the third year of a bull market tends to be choppier. However, conditions are in place for balanced and well-diversified portfolios to still deliver positive but moderating returns in 2025.

Angelo Kourkafas, CFA
Investment Strategist

Source: 1. Bloomberg

Weekly market stats

^{Source: FactSet, 12/13/2024. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results. *4-day performance ending on Thursday.}

The week ahead

Important economic releases this week include PCE inflation and the FOMC meeting.

Review last week's weekly market update.