Macro data and central banks miss the year-end memo

Primary market and trading activity may be declining as is typical in late December, but macro data doesn’t sleep, and central banks haven’t got the memo on the wind-down into year-end either with policy meetings at the Federal Reserve (Fed) and the Bank of England (BoE) scheduled for Wednesday and Thursday respectively.

Monday’s flash Purchasing Managers’ Index (PMI) estimates for December were particularly important for the Eurozone. Despite strong Q3 GDP data for the bloc (excluding Germany) and a roughly unchanged October PMI print, November’s PMIs were surprisingly poor. It is a well-known fact that manufacturing is going through tough times globally, so November’s manufacturing PMI reading in the mid-40s (anything below 50 indicates contraction) didn’t raise many eyebrows. Worryingly though, the Eurozone’s services PMI reading in November slid below 50 for the first time since January. Was this just a bad month, or a suggestion of potential recessionary trends?

The flash December estimate showed a steep recovery in the services PMI reading, which at 51.4 was well ahead of the Bloomberg consensus for a flat print of 49.5. The manufacturing number remained in the mid-40s, resulting in a composite PMI of 49.5. The detail of the report highlighted not only the divergence between manufacturing and services, but also the gap between France and Germany and the rest: “The rest of the Eurozone (i.e. excluding France and Germany) posted a solid increase in output at the end of the year, with the rate of expansion reaching a six-month high.” Overall, we think this was a good set of PMIs for the Eurozone even if the absolute numbers are still low.

The UK PMIs were also important given market participants are very much still gauging the impact of the Labour government’s budget. The services reading rose by less than expected to 51 from 50.8 in November, while the manufacturing was better than expected at 48.5. The detail offered some interesting insight on the UK labour market, with the report noting that a combination of softer demand, rising employment costs, and squeezed margins contributed to a further reduction in private sector headcounts (the latest decline in workforce numbers was the steepest since January 2021). We are seeing mixed messages from the UK labour market, however, since on Tuesday we learned that wage inflation continues to increase and is now back over 5%. UK Consumer Prices Index (CPI) data on Wednesday morning showed inflation rose to 2.6% in November, up from 2.3% in October, which was marginally better (lower) than expected but with core and services inflation still significantly higher than the BoE’s comfort zone.

On the other side of the pond, Monday’s PMI numbers simply confirmed US exceptionalism; the composite reading of 56.6 is not far off a five-year high, while the services reading of 58.5 is in fact a five-year high. The US economy remains strong, and stronger than most people thought it would be by this stage in spite of manufacturing sector woes.

Fed projections look too optimistic

Moving on to the central banks, markets are pricing in virtually a 100% probability of a 25bp cut from the Fed on Wednesday, just as they did for the ECB last week. Most of the attention will be on the Fed’s new Summary of Economic Projections (SEP) and the new ‘dot plot’ of members’ interest rate projections. September’s SEP had median GDP growth at 2.0% every year from 2024 until 2027. We think next year’s number will be revised higher as the economy carries stronger momentum than expected into 2025. Unemployment projections at 4.4% for next year are unlikely to move too much. The Fed’s preferred Personal Consumption Expenditures (PCE) measure of inflation will be key. Its own end-2024 expectations of 2.3% and 2.6% for headline and core PCE respectively are likely to prove too optimistic, with markets expecting a mild acceleration in November’s numbers (published on December 20) to 2.5% and 2.9%. Equally, the Fed’s end-2025 forecasts of 2.1% and 2.2% look a tad too cheerful and are likely to be revised up in our view. Markets are currently pricing in a Fed Funds rate of 3.85% for the end of next year, which reflects the expected 25bp cut on Wednesday and two further cuts in 2025. The current dot plot shows four cuts for next year, while the Bloomberg consensus expects this number to be revised down to three – we agree with the latter. It is far from a done deal that the Fed will manage to cut three times in 2025, but it is certainly possible if the labour market continues cooling off at the margin.

The BoE is widely expected to keep rates unchanged on Thursday. For next year, markets are pricing in just over two 25bp cuts. The interaction between an expansionary budget (which is also likely to hurt employment and private investment) with inflation that refuses to come back to target, and elevated wage inflation in particular, makes it difficult to predict what Gilts might do in the coming months. The adjustment in yields has been brutal since the lows of September, with a sell-off of close to 80bp in the 10-year Gilt, similar to that of the 10-year US Treasury in the period. For all the uncertainty surrounding some UK data, 10-year Gilt yields could well start 2025 100bp wider than they started 2024, something that is definitely worth keeping in mind in a year where carry is likely to be the main contributor to returns.

While we can expect some price action in government bond markets as a result of the Fed and BoE meetings, we do not think they will rock the boat too much. With growth numbers persistently strong in the US and a hint that October’s gloom might have been just a blip in the Eurozone, we deem these and our expectations for the central banks meetings this week consistent with our outlook for next year.