At its December meeting, the Federal Reserve turned towards interest rate cuts. Doing so hit the dollar and fuelled the appetite for risky currencies and assets. Other central banks did not pursue a similar path. The ECB Governing Council did not discuss cuts. Three out of nine Bank of England policymakers voted in favour of a hike. Interest rates in Norway rose to 4.5 per cent. The SNB presented inflation forecasts that were high compared to market estimates. The apparent contrast intensified the reshuffling to which the exchange rates were subjected. The dollar lost ground against the other G-10 currencies, with the Norwegian krone being the strongest of the main currencies and the EUR/USD approaching the 1.10 level.
US dollar: Federal Reserve takes a step towards cuts
The Federal Reserve left interest rates unchanged for the third consecutive meeting. The cost of money has remained in the highest range in 22 years of 5.25-5.50% since July. In the statement, the language used to scare the possibility of a resumption of hikes was unequivocally softened. It was noted that disinflation is progressing rapidly, but price pressures are still strong. The Fed chair at the conference acknowledged that another upward move in rates is no longer the baseline scenario and that the progressive decline in price momentum towards the target is causing attention to shift to when to start cutting.
The latest FOMC projections, presented yesterday, show that the reduction will stand at 0.75 percentage points in 2024. Hence, the optimal rate level is 25 bps lower than in the September projections. According to policymakers, in two years' time, the cost of money should be in the range of 3.5-3.75%. The shifts in the median expectations of FOMC members are stronger than forecasts had assumed. Investors interpreted yesterday's meeting as a signal to deepen the valuation of cuts. For the next 12 months, they assume twice as much easing as the projections imply, with the first cut coming in March or May at the latest.
Euro: lack of discussion on cuts pushed the EUR/USD towards 1.10
The European Central Bank left interest rates unchanged for the second consecutive meeting. The deposit rate will remain at its highest-ever ceiling of 4%. The main central banks - the Fed, the ECB and the Bank of England - made their final increases in the third quarter. No one believes in a resumption of tightening anymore. Investors have already been thinking about rate cuts for several weeks. The hierarchy on the currency market will be determined by which monetary authority delays monetary easing the longest. So far, investors have been betting that the ECB will make particularly sharp cuts. After all, it is hardly surprising - the eurozone economy is still teetering on the brink of recession, and consumer price dynamics have slipped from double-digits to 2.4% y/y in a year. Prior to Thursday's decision, the market had assumed that the deposit rate would be as low as 2.5 per cent in a year's time, with the first reduction coming in April at the latest.
By lowering its estimate of the optimal rate level for the end of 2024 on Wednesday and suggesting cuts of a total of 75 bps, the Federal Reserve hit the dollar. The ECB's projections have a more neutral tone and are not likely to encourage a tightening discount of future cuts. The new projections lowered both estimates of economic growth and the strength of price pressures. GDP growth in 2024 is projected at 0.6% (revised from 0.7%), and average annual inflation growth is at 2.7% (previously 3.2%). CPI dynamics below 2% will not fall until 2026, and may temporarily rise in the near term, which seems to dismiss the prospect of a cut. At Ch. Lagarde's press conference, it was stated that the Governing Council (unlike the Fed) had not discussed rate cuts. This translated into a jump in the euro against other G-10 currencies (including a rally in the EUR/USD towards 1.10), thanks to a weakening belief that easing is imminent.
More broadly, it can be said that the US and eurozone economies are moving in opposite directions. This also applies to the labour market. On the Old Continent, wage dynamics have not yet peaked, while in the United States, there are signs of weakening demand for labour, including a decline in the number of vacant positions. Conotoxia's currency forecasts assume that the euro will gain against the franc, pound and dollar next year.
Swiss franc: CHF the strongest of the G10 currencies in 2023 thanks to the SNB
The Swiss National Bank kept interest rates at 1.75% and announced the end of the cycle. The last hike was made in June, a year after the shocking start of the tightening, which saw the cost of money rise by 200bp, hitting those paying off mortgages in francs hard. Investors expect the first cuts as early as the first half of next year and are pricing in a return of rates to the 1% ceiling in twelve months' time. In September, the market counted on a continuation of the tightening. This time, the decision was in line with forecasts, with investors even seeing a cut as the marginally more likely move. This was all due to inflation, which, contrary to the SNB's forecasts, instead of rising towards 2% in the fourth quarter, fell to 1.4% year-on-year in November.
In Switzerland, interest rate rises were completed earlier and, above all, at a much lower level than in the eurozone or the US. Nevertheless, the SNB's policy is the foundation of the CHF's strength. At 2023, the franc is the strongest of the major currencies. Records of its strength against the euro were reached in the first part of December. The franc's strength is due to the active support of the central bank seeking to maintain the strength of the CHF. In doing so, the SNB is keen on a stable, real effective exchange rate, a measure that reflects the structure of foreign trade and takes into account differences in inflation dynamics. Inflationary pressure in Switzerland is weaker than in other economies, which means that for this indicator to remain stable, the franc needs to appreciate against the euro, the dollar or the pound.
The franc should gradually equalise in value with the single currency in 2024, but this will be a long process. Inflation in Switzerland has been below 2% for the past six months, and with each month that CPI dynamics remain below this barrier, the Swiss National Bank will become convinced that price pressures have been contained. This is also why the new macroeconomic projections were particularly important at today's meeting. According to them, CPI dynamics are expected to be at 2.1% next year and to fall to 1.9% in 2025.
The central bank's forecasts are clearly above market expectations, as are the Swiss government's estimates. Nevertheless, we believe that the previous preference for the franc to be strong, which has been translated into currency interventions over the past several months, will weaken over time. However, we do not expect a 180-degree turnaround and a move to weaken the currency to make exports more attractive. Therefore, a return of the EUR/CHF to 1.0 will have the character of a choppy drift and will also be conditioned by how quickly the European economy is on the path to recovery.