What goes up must come down, is the saying. And that might apply to interest rates next year, at least if bets from the market are anything to go by. Many economists, of course, argue that interest rates will likely stay high until 2025. Inflation won’t come down that fast, they say. Central bankers are insistent that rates will stay high, as well. They see inflation still isn’t down to target, and therefore most argue that it’s too early to talk about cuts.
But, trading success is built on avoiding risk. Which means being prepared for multiple scenarios, and considering what would happen if the leading economic and monetary authorities are not right about their future forecasts. What could happen if or when major central banks start easing?
While central banks were hiking, theoretically there was no upper limit to how far they could go. Sure, there were limiting factors such as the impact on economic growth, or the cost of debt, or how it would affect the banks. But there was no technical reason to assume one central bank couldn’t hike more than another.
But the situation changes when rates are going the opposite direction. Although it’s true that rates can be cut back into negative, it provides a larger psychological barrier. More importantly, it was generally thought that central banks had reached their easing limit during the pandemic.
The experience of many central banks opting for negative rates showed that there was little benefit from them, and exiting “ultra easing” was particularly difficult. The extreme inflation of the post-pandemic was seen as a relief valve for many economists that were worried central banks couldn’t exit negative rates under “normal” circumstances. Those concerns haven’t entirely gone away.
Therefore, it’s likely that central banks will be extra hesitant to go into negative rates again. And those that do, will almost certainly not exceed their rates of 2019. Which means that central banks that have raised less have less cutting to do, if cutting is back on the menu.
The more aggressive the central bank was over the last two years, the more room it has to ease and support the economy if needed next year. The Fed can cut rates by 525 basis points and still be in the green. Meanwhile, the ECB can only cut 400 bps before turning negative. And if it cuts more than 450 bps, then that would be a new record low.
That also gives the Fed more room to adjust rates, even if it isn’t looking to cut all the way to the bottom (as would be the likely case in a recession-like scenario). Even considering all the rate cuts that the dovish market is expecting for next year, the Fed would still have rates higher than the ECB currently does.
The BOE is also in a position to cut rates by 125bps before hitting the ECB’s current rate. Meanwhile, with interest rates at 4.35%, the RBA is in a worse position to cut than the ECB. Across the Tasman Sea, the RBNZ is in a position closer to the Fed at 5.5%, meaning that the Kiwi has more potential for weakness than the Aussie.
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- Source: https://www.orbex.com/blog/en/2023/12/2024-the-year-of-central-bank-cutting
