Call Participants

ATTENDEES

Diego Iscaro

Harumi Taguchi

Ken Wattret

Kristen Hallam

Lawrence Nelson

Shuchita Shukla

Unknown Attendee

Presentation

Kristen Hallam

We have an exciting development to share with you, the Economics and Country Risk podcast and the Maritime and Trade Talk podcast are joining forces to bring you a brand-new show, The Decisive podcast. Join our team of seasoned analysts as they explore the ever-changing landscape of economics, country risk, maritime trade and supply chain. Each episode of The Decisive podcast features, insights and intelligence that will empower you to make decisions with confidence. Whether you're a business leader, investor or simply curious about the forces shaping our world, The Decisive podcast is here to provide you with the knowledge you need to stay ahead. The Decisive podcast will launch on this feed in June. So if you're already subscribed, you're all set. If you're not, subscribe now, so you don't miss our premier episode of The Decisive, your go-to resource for expert insights and analysis. And now for your episode of Economics and Country Risk.

Unknown Attendee

You're listening to the Economics and Country Risk podcast from S&P Global Market Intelligence. In each episode, our experts will provide you with the where, how and when to make decisions that transform your business.

Question and Answer

Kristen Hallam

The most common questions we get about monetary policy are when and how much. Today, we'll have a deeper, more nuanced discussion that sets the scene for monetary policy pivots and takes us through the implications and impacts of monetary policy for your business. Joining us to deliver these insights are my colleagues from S&P Global Market Intelligence; Ken Wattret, Vice President, Global Economics; Lawrence Nelson, Senior Economist, U.S. Macroeconomics; Diego Iscaro, Head of European Economics; Harumi Taguchi, Principal Economist, Asia Pacific Economics; and Shuchita Shukla, Senior Economist, European Economics. Let's go ahead and start our discussion.

Ken, we've been making the case for a pickup in global growth near term. What is behind those assumptions?

Ken Wattret

Yes, we have indeed been making the case for a pickup. We've been revising our global growth forecast since the beginning of the year. That may seem a little odd given that we've seen rising geopolitical risks and uncertainties related to those, including from events in the Middle East, but it's actually consistent with the positive signals that have been emanating from various indicators, including our own PMI data. And those improvements in the PMI data in turn reflect a few tailwinds for growth. And one of those is more favorable financial conditions. And we need to remember that while U.S. rate cut expectations for this year have been scaled back, which we'll talk about shortly. Central Bank easing cycles are well underway in many economies, particularly emerging economies around the globe.

And that's because many of their central banks grasp the nettle responded quickly and forcefully to the surge in inflation that we saw back in 2021, '22, and they've been able to lower interest rates since the autumn of last year. And of course, they're not all moving at the same speed, that reflects differences in inflation prospects, exchange rate risks, their mandates, but some have been cutting interest rates quite rapidly and we expect those rate cuts to go a bit further. Many economies in Latin America, and emerging Europe, for example, have already cut rates significantly, and we think we'll continue to do so.

Kristen Hallam

Now Ken, you mentioned speed there. How quickly will rates decline once we start seeing pivots from the Fed, the ECB and so on?

Ken Wattret

Yes. I mean that's a really good question, and I think we need to consider a few different outcomes. Ideally, inflation would drop swiftly back to the Central Bank targets and then interest rates could come down quickly as a result. That's certainly the best case for growth prospects, but it's not really happening. Then one alternative is late but large, meaning central banks take a cautious approach, wait until we're absolutely convinced that inflation will sustainably return to target. And then they end up cutting interest rates quite quickly once they eventually start to come down. And the situation in the U.S. is similar to that.

Another alternative is go early, but gradually, they anticipate that inflation will continue to come down, but they move cautiously because they see sticky prices in some areas, for example, that's more akin to what we expect from the ECB. There's been some stickiness in services inflation. They don't want to overdo the easing and run the risk of going too far and then reigniting inflation pressures, but they can reduce the degree of policy restriction in a gradual way, and that does give some support to economic activity.

And then we also need to think about some tail risks, including an escalation of conflict in the Middle East and a supply-driven spike in oil prices. That would create a real dilemma for some central banks. Inflation would rise, but economic conditions would worsen materially. They'd probably look through the initial energy-driven spike in inflation. But if second round effects through to the pay growth, threatens to materialize, they'd have to tighten, and that's the worst-case scenario that would probably result in a global recession.

Kristen Hallam

So Ken, do we see interest rates coming back down to pre-pandemic levels in the near term?

Ken Wattret

Well, the short answer to that question is no, we don't. We became used to very low levels of policy rates in the aftermath of the global financial crisis and that period of rather low, in some cases, persistently below target inflation rates and interest rates for some central banks went below 0 and stayed below 0 for quite some time, but they reflected very exceptional circumstances. The global economy was facing strong disinflationary forces for various reasons. And with those inflation rates for some central banks persistently below where they wanted them to be, they ran ultra-accommodative monetary policy to try to raise inflation, including unconventional measures. But those inflation undershoots are unlikely to be repeated in a lasting fashion going forward, given various shifts in the global economy, many of which actually look structural but that could be reduced labor supply, reshoring trends following the pandemic and geopolitical uncertainties. We think we're in a new normal.

Kristen Hallam

So let's shift our discussion to the Fed. Lawrence, the Fed has recently shifted to a more cautious stance, signaling that rates are likely to stay higher for longer than previously expected. So why is the Fed still leaning toward cutting rates rather than raising them while inflation remains above their 2% target?

Lawrence Nelson

That's right, Kristen. The Fed is in a tricky spot right now, cutting rates too soon risks an inflation resurgence, which would potentially embed higher inflation into expectations while cutting to late risks inflicting undue harm upon labor markets and the economy as a whole. Now in hindsight, the Fed was too late to start tightening policy as inflation began its upward trajectory in 2021. They've been leaning towards cutting rates for a while now because they're wary of making the opposite mistake by holding rates too high for too long and potentially instigating a recession. And just taking a step back, just a few months ago, there was widespread confidence amongst policymakers that they would be cutting rates this year and presumably soon. This view was supported by the rapid disinflation we saw in the U.S. over the second half of last year and a desire, again, to avoid the negative growth concept of maintaining overly restricted policy for longer than was necessary.

And since then, the data have not cooperated with that narrative as inflation has turned sharply higher to start this year. This has prompted policymakers to signal a reset in their outlook, emphasizing a lack of urgency to cut rates while progress restoring price stability has stalled. Still, the framing of this message makes clear, policymakers are inclined for the next move to be a cut. Now this increased caution from policymakers, coupled with an upward revision to our own inflation forecast, has led us to push back our expectation for the first rate cut to the December meeting of this year. And the committee remains devoutly data-dependent as they consider how long to hold policy at its current level. The Fed still views the threat of an inflation resurgence following a premature rate cut as the greater long-term risk because it would undermine their credibility as responsible stewards of price stability.

One could easily argue that it is that very credibility that has allowed them to achieve the progress we've seen on bringing inflation down without the pain and labor markets that Powell had once suggested would be required to restore price stability. So while the FOMC maintains an easing bias, we have still heard from some policymakers recently who are leaving the door open for further rate hikes, if inflation remains stalled above their target. And for his part, Jerome Powell said it is unlikely the next move would be a hike. So he's not ruling it out categorically, but it isn't the baseline expectation for now and they certainly seem inclined for the next move to be a cut.

Kristen Hallam

All right. Thank you for that, Lawrence. Let's compare that with the ECB expectations that we have. We currently expect the ECB to cut rates in June and the Fed, as Lawrence just said, to start cutting rates in December. Why do we think the ECB will cut in June, Diego?

Diego Iscaro

Yes, that's right, Kristen. We expect ECB to start cutting rates for the Fed. And we are quite confident about a cut for several reasons. If you look at inflation in the eurozone, it is true that inflation remains slightly above the ECB target of 2%. And there are also still concerns about how sticky service price inflation remains. But we think the progress on inflation has been quite significant and definitely significant enough to allow the ECB to start easing policy.

And it's also been reflected in communication from President Lagarde and also from several members of the ECB's Governing Council, including those traditionally on the most hawkish side of the debate. There was inflation in the eurozone, it has fallen quite sharply, but not only headline inflation but also core inflation which includes areas of the economy where the monetary policy has a stronger influence. There are also indications that wage growth is slightly to have peaked late last year and also that firm's profit margins have been limited by still quite subdued demand levels. And these factors are likely to give the ECB more confidence that policy can be eased as early as in June.

Kristen Hallam

Thanks, Diego. And what is the probability that the later start to U.S. rate cuts will influence the ECB?

Diego Iscaro

Yes, that's a very relevant question given our revised outlook for the Fed. Now the ECB has repeatedly stressed that it's an independent central bank and the ECB and the Fed have diverged in the past. Although in those occasions, the ECB tended to follow the Fed and not the other way around. The sure answer to your question is that as the U.S. rates remain higher for longer, will not prevent the ECB to start cutting rates first. But it's unlikely that ECB will completely ignore what happens on the other side of Atlantic. If monetary policies diverge too much, there is a risk of a large depreciation of the euro. And although the ECB does not have a target for the exchange rate, a weaker euro could have inflationary impact by increasing the value of imported goods and services. But we still think that the euro will need to weaken quite significantly, probably moving towards parity for the ECB to start to significantly deviate from current market expectations.

Kristen Hallam

Let's talk a little bit more about exchange rates. Lawrence, what would be the impact of a rate cut on exchange rates for the dollar?

Lawrence Nelson

So all else equal, a Fed rate cut would put some downward pressure on the dollar. However, higher interest rates in the U.S. relative to our prior assumptions, we're not assuming a hike, but because we pushed back our expectation for the first cut to December, this puts some upward pressure on the dollar in foreign exchange markets this year, again, relative to our prior assumptions and as we're assuming a sooner start to cuts in the ECB and elsewhere. So this is reflected in the upward revision to the dollar in the U.S. macro's latest-based forecast. We show the dollar rising through the second quarter before edging down a bit through the fourth quarter and then this pressure eases next year as rate cuts accelerate.

Kristen Hallam

Thanks for that. Harumi, let's talk about the Yen. The Bank of Japan has made a different kind of policy pivot. They've raised rates. What impact has that had on the Yen?

Harumi Taguchi

We had expected some collection with the Yen depreciation following the decision of the Yen in negative interest rate policy in March as it would narrow the worse Japan interest rate differentials, but the Yen has unexpectedly weakened after the monetary policy announcement. This is because the BOJ announcement indicated that accommodating financial conditions will be maintained for time being. And in addition to that, the U.S. policy rate forecast is going to be affected to the interest differentials.

Kristen Hallam

And Shu, we saw many Central European banks launch rate cuts last year, well ahead of the ECB. What has been the impact on those currencies that are tied to the Euro?

Shuchita Shukla

Yes, the central banks of Czechia, Hungary and Poland all launched rate cuts late last year, thanks to decisive disinflation, as Ken mentioned. And Romania hasn't yet cut rates officially, but even there, the short-term rate has declined by over a percentage point since early 2023, thanks to liquidity surplus in the banking sector. Now the narrowing of rate differentials in a risk of environment, of course, means depreciatory pressures on the local currencies. But we've had a few country-specific crosswinds to factor in over the last 12 months. In Poland, the pre-electoral pivot to monetary easing was short-lived and the new government has opened access to EU funding, which has supported this largely.

This was also the case for the Hungarian Forint, where unblocking of some EU funding supported the currency in late last year. But in 2024, we've seen some renewed pressures on the currency from various sources, including heightened discord between the Central Bank and the government. In comparison, the Czech Koruna and the Romanian Lei have been rather stable. But it's quite important to note for the region that the easy part of disinflation is behind us and that most of these countries will see either reinflation above their targets or a protracted last mile of decline to that target range. So when you add to that the cautious easing by ECB that Diego just mentioned, what we are seeing is a less dovish monetary policy outlook ahead with rate pauses in Hungary and Poland and cautious small cuts in Czechia and Romania, respectively.

Kristen Hallam

Let's talk about implications for growth. So Diego, if the ECB does indeed cut in June, how quickly do we think rates will come down after that?

Diego Iscaro

Picture-wise, Kristen, what is important to highlight is that rates are likely to fall less quickly than they have gone up in 2022 and 2023. Analogies are not my fault, but if they took off like a rocket, we think that they will land more like an aeroplane, if that makes any sense. And one of the reasons is that...

Kristen Hallam

I like that analogy, I like that. Sorry, go ahead.

Diego Iscaro

Thank you. Well, now one of the reasons is that the pace of this inflation in the eurozone is literally gradual, particularly when we look at core inflation and services. And also, there is a credibility issue from the ECB side as you know, the ECB is seen from in certain areas having reacted quite late to the rising inflation and it will not want to risk easing too quickly, particularly when labor market conditions remain still relatively tight and the economy, although it's not doing great, it's not doing terrible either. Now in terms of how this translates into the figures, again, I'm quoting our upcoming forecast, we now expect the ECB to cut rates 3 times this year for a total of 75 basis points starting in June.

Kristen Hallam

So Lawrence, once the Fed pivots, how quickly do you think rates will come down. And I don't know if you want to borrow that metaphor that Diego used about the rocket, the airplane, is it going to be a hang glider, how quickly do we think rates will come down?

Lawrence Nelson

I think it's a pretty good analogy from Diego there. We also would expect the Fed to proceed gradually at first as they start to forecast. We project the Fed will cut at every other meeting to start next year after making the first cut in December with the cautious messaging we've heard from policymakers of late. As long as progress on inflation remains gradual and uneven, they will want to start to eat policy slowly at first just to make sure there's really no doubt, it's headed back to 2% rate cuts then accelerate in our forecast in the second half of next year as payroll gains slow and the unemployment rate rises gradually, while inflation continues to come down.

Kristen Hallam

And what will the impact on growth be, Lawrence?

Lawrence Nelson

So on our May forecast, we revised down very slightly. Our projections for U.S. GDP growth in 2025 and 2026. This downward revision reflected the recent tightening of financial conditions, which was driven by a market reevaluation of the outlook for rate cuts from the Fed this year. At the beginning of April, futures markets were pricing in better than even odds of a rate cut -- at least one rate cut by the June meeting of the FOMC. Market expectations have since shifted and they now expect the September meeting to feature the first rate cut. Consequently, over the month of April, the 10-year Treasury note yield rose by about 50 basis points, private yields rose nearly as much and equity values in the U.S. fell about 4%.

So tighter jump of financial conditions in our forecast, coupled with the later start of Fed rate cuts relative to our prior assumptions are responsible for higher treasury yields and weaker equities in the near term in our forecast, which is a drag on growth. As rate cuts accelerate next year and continue into 2026, growth continues, but it does fall below trend over 2025 to '26. This slowdown reflects in part the lagged effect of the past monetary tightening as well as some diminished tailwinds. Two examples of these diminished tailwinds are the succession of rapid growth of infrastructure spending as well as manufacturing investments and structures. And then looking ahead with the stimulative effects of the anticipated easing of policy will help the U.S. to avoid a recession. So in other words, we do project a soft landing.

Kristen Hallam

All right. And one more for you, Lawrence. So lower rates are better for growth, but a slower pace of cutting isn't necessarily an issue as long as the underlying economy is strong, what indicators will you be watching to gauge the path forward on monetary policy?

Lawrence Nelson

Well, I think first and foremost, obviously, inflation. That's the big thing. That's why policy was tightened in the first place. The data dependence of the Fed means that the focus has to be on outcomes, not forecast. And of course, this means that our monetary policy outlook going forward is only going to be as accurate as our inflation forecast. Come to mind there include an oil price shock or disruptions to international shipping lanes, either of which could arise from the various geopolitical tensions that Ken touched on earlier. And while, of course, we all pay for food and gas, policymakers generally place greater emphasis on the core measures of inflation, which exclude those components because they are volatile. And doing so, does give a better signal of the underlying trend of inflation.

Also inflation expectations are going to be critically important. They need to be monitored because should they start to rise that would raise concerns amongst policymakers that inflation is becoming embedded in the economy and will require a more restrictive policy stance than otherwise would be appropriate. But also placing increased attention on the labor market data now, consistent with the second of the 2 paths that Jerome Powell highlighted in the post meeting conference last week. So there, in addition to the big headline grabbers like the unemployment rate and low payroll gains, another series we'll be watching closely is the unemployed workers. This is a good measure of labor market tightness that we've heard highlighted by several policymakers on the FOMC. Additionally, claims for unemployment insurance benefits, they tend to be pretty boring until they aren't.

Initial claims have remained a bit below the 2019 average in recent months, while continuing claims have settled a bit higher. These are higher frequency data than the other monthly series so they often have issues with seasonal adjustment around holidays, and things like that. So you can't overreact to any sudden movements week-to-week on these, but a sustained upward trend would be a clear precursor to a recession. While declines would indicate labor markets are remaining tight and would be in parallel for the progress on inflation coming through easing of wage gain. Then lastly to say the prospect of revisions changing the narrative that on either inflation or labor markets is something that certainly should not be discounted and something we'll be keeping an eye on as well.

Kristen Hallam

All right. It sounds like you'll be busy there, Lawrence. Diego, how about you? What indicators will you be watching?

Diego Iscaro

On the inflation front, so given the likely impact of higher oil prices on headline inflation, particularly between May and July, I think we need to keep a close eye on service price inflation, which has been quite sticky. As we mentioned several times, it fell for the first time in April, and we need to see further declines over the rest of the second quarter and the second half the year for the ECB to start easing policy. And for service price inflation to ease, I think we need to see a further easing in wage inflation. Lastly, we'll definitely be looking at the updated ECB macroeconomic projections, which will be published alongside June's rate decision and that should give us a good indication of how confident the ECB is that inflation is heading back to target in a sustainable way. So these are the main variables we will follow to see if our projections are on track.

Kristen Hallam

Thanks for that, Diego. And Harumi, let's shift back to the BOJ. How quickly and how much could the BOJ raise rates and what would be the implications for growth there?

Harumi Taguchi

We have recently moved up our project -- policy rate hikes by BOJ considering the impact of the high import price associated just weakened. But we still expect the BOJ's monitary policy hikes to be slow and steady. The next policy hike is likely in October 2024, and we expect one follow-on rate hike per year in 2025 and 2026. Rapid moves are unlikely because the BOJ's loss and inflation outlook is modest. The bank expects the BOJ to grow by around 1%, and the core CPI inflation is stay-on 2% through fiscal year 2026, which is since the end of March '27. And thus, those are in line with what we expected too. And bank needs to be cautious and carefully monitor the impact of the policy rate hikes each steps as the impact of the policy rate hikes on business and households could be unexpectedly large because for a long time, they have been able to allow funds without considering the possibility of a higher interest rate.

How much BOJ could rise rate by, it's a tough question. Japan has not had positive interest rate for quite a long time. So even the BOJ has hardly specified the level or the real interest rate that would be neutral to the economic activity and prices the so-called the neutral -- natural rate of interest. Normally the timing of that, this could be at the level or the natural rate of interest plus inflation. But we think the timing of that could be a lower than level derived from the -- any model that suggests the -- in the BOJ's latest outlook because the downtime with the natural rate of interest and also the weak potential growth.

The future rate hikes, if they are slow to align and also a few in number, it's unlikely to weak economic activity significantly. While the negative interest rate policy never result in the overheated financial needs because in fixed investment plan for the fixed year 2024 in March indicated to be a solid demand for fixed investment. This said, the higher interest rate could cost the bank lapse and also delays to the capability residential investment, which is affected by the high input cost. And also gradually weigh on the household, the cautious private consumption because of the increased mortgage loans that could be possible.

Kristen Hallam

And Harumi, what indicators will you be watching that might signal monetary policy changes?

Harumi Taguchi

So CPI is, of course, but the primary indicators will be monthly cash earnings and the household spending. Although those index -- indicators have issue with respect to the sample base. And we're also be watching the service prices in CPI and also the inflation expectation from the taken survey as well as household inflation expectation from the opinion survey of the general public's views and the behavior survey by BOJ.

Kristen Hallam

And Shu, how about you? What indicators will you be watching as the Central European banks fine-tune their monetary policy response going forward?

Shuchita Shukla

So a couple to highlight here all impacting the inflation dynamics in the region. Firstly, pressures on the local currency from both global risk sentiment and rate decisions by the major central banks as well as domestic relations with the EU, especially in the case of Poland and Hungary. But equally important are any signs of wage price spiral given tight labor markets in the region and expansionary fiscal policy impacting personal disposable incomes of households, especially in Romania, where we've seen some pretty significant pre-electorial spending. So in addition to long-term inflation expectations and the stickiness of services prices, other monetary tools like lending caps and liquidity positions are really good leading indicators to assess any shift in the policy rate environment for Central Europe.

Kristen Hallam

So I'd like to do a little lightning round and go to each of you for a top takeaway. Ken, I'll come to you first. What is a key takeaway that you have for our audience today on monetary policy?

Ken Wattret

Yes. Thanks, Kristen. I think the first thing I would emphasize really is that inflation has proved a bit more stubborn than anticipated over the last 2 or 3 quarters, and that's obviously having a restraining effect on what central banks can do. We've had the Fed, reg cutting has been pushed back. That then has an impact on global monetary conditions because of the central banks who are reluctant to see their exchange rates depreciate, build up some inflationary pressures, therefore, have tighter than otherwise monetary policy as well. We're heading in the right direction. We do expect inflation will continue to moderate. We do expect that globally interest rates will come down, but it's taking a bit longer to get there.

Kristen Hallam

Lawrence, how about you, key takeaway for our audience today?

Lawrence Nelson

Similar to what Ken just said and for those in our audience who are Fed watchers, I hope you'll forgive me for borrowing some language that they've been using. But I would say the Fed is on pause. They're waiting for more inflation data to emerge that gives them greater confidence that inflation is sustainably back on track to 2%. And until then, they are happy with the current stance of policy and ready to sit back and let it do its work.

Kristen Hallam

All right. And Diego, key takeaway for our audience.

Diego Iscaro

Kristen, I think for the eurozone, the main message is that we forecast interest rate cuts to start soon despite the expected late Fed pivot. And while we think that the impact on credit conditions and demand is likely to be modest and lagged, we still project lower rates to be a positive for growth. And we think that easing monetary policy alongside falling inflation should help to provide some support for activity, particularly in late 2024 and in 2025.

Kristen Hallam

And Shu, how about you, key takeaway for our audience today?

Shuchita Shukla

So generally speaking, and perhaps for the outliers of a region in some cases too, currencies in emerging Europe tend to be vulnerable to global pivots in monetary policy, and this time is no different. So as far as the domestic monetary policy conduct is concerned, the writing on the wall everywhere is proceed with caution whether that be with defensive pauses like in Hungary, Poland, Turkey and Russia or with calculated easing ahead like in Czechia and Romania.

Kristen Hallam

And finally, Harumi, key takeaway for our audience today.

Harumi Taguchi

The BOJ's policy rate hike is slow and steady, it is likely only just 3 times for this year until 0.75% in 2026. And for the rate hikes, wage increases remain the key for the policy decision.

Kristen Hallam

And that is all the time we have for today. Thanks to our dream team of economists, Ken, Lawrence, Diego, Harumi and Shu, and thanks to you for engaging with us today until next time.

Unknown Attendee

Thank you for listening to the Economics and Country Risk podcast. Connect with us on LinkedIn and Twitter and don't forget to subscribe to the podcast, so you never miss an episode.