Executive summary
This week, we look at four critical issues:
- Fed: the pivot we’ve all been waiting for. After the sharpest monetary tightening in decades, the Fed is set to cut interest rates by 25bps next week. The August CPI print indicated that inflation continues to soften while the unemployment rate is on a firm upward trajectory to 5% in the next months, from 4.2% in August. The US economy has remained remarkably resilient so far, helped by loose fiscal policy and strong immigration, as well as the strength of corporate balance sheets. Although recession risks have risen, we continue to expect a ‘soft landing’. In this context, the Fed must tread carefully between the risk of being behind the curve and the risk of re-heating the economy. We expect a balanced approach of back-to-back 25bps interest rate cuts in each meeting starting next week, which would bring the Fed funds rate (upper range) down to 3.5% in July 2025 from 5.5% currently.
- Bank of England (BoE): on pause amid solid momentum. After delivering its first rate cut in August, we expect the BoE to pause its loosening cycle at next week’s meeting as inflation is set to pick up again to +2.8% y/y in November on the back of unfavorable base effects and the Ofgem energy price cap increase by +10% in October. The inflation outlook should improve again from December onwards and we expect the 2% target to be reached sustainably before mid-2025. In this context, the BoE is likely to cut the bank rate by 25bps in November, skip December and then cut by 25bps in each meeting in 2025, stopping in September 2025 once it reaches 3.25%.
- Poland: Favoring growth over fiscal consolidation carries risks. Poland’s economic growth should remain robust, driven by domestic demand on the back of expansionary fiscal policy (2024: +3%, 2025: +3.8%). However, the budget proposal for 2025 calls fiscal consolidation into question and harbors medium-term fiscal risks. We expect the government to begin to consolidate its budget from 2026 onwards, thereby stabilizing the public-debt-to-GDP ratio at around 56%. In a downside scenario with no fiscal consolidation, public debt would continue to rise and exceed 60% by 2027. In the short term, the Polish budget proposal poses inflationary risks and is likely to delay interest rate cuts until Q2 2025.
- The end of the US yield curve inversion: what now? After the longest inversion in history, the US yield curve has returned to a positive slope. Does this mean a recession is looming? Not quite as we still believe in a soft landing without a sharp sell-off in risky assets. Nevertheless, we prefer bonds over equities at this time. Historical evidence shows capital flows have typically moved in the opposite direction at this stage of the yield curve shift; hindsight reveals this was often not the optimal financial choice.