While AXA IM doesn’t expect any hard announcement from the Fed and the ECB nor a massive change of communication, it will be difficult for Jay Powell and then Christine Lagarde to completely ignore the dramatic shift in the monetary policy trajectory now expected by the market, Gilles Moëc explains in his weekly Macrocast.

This week, AXA IM Group Chief economist and Head of AXA IM Research Gilles Moëc focusses on the upcoming monetary policy decisions of the Fed and the ECB. He expects the biggest challenge will be managing market expectations.

AXA IM: Difficult for Powell and Lagarde to ignore dramatic shift expected by markets

Fed: Talking to the markets

“We think there is a strong case for the Fed to try to steer the market away from its most extreme pricing since broad financial conditions are on the brink of standing in the way of what the central bank has been trying to achieve,” Moëc says.

The Fed has one handy tool at hand to signal a disagreement with the market. Of course, the ‘extra hike’ in the previous dot plot failed to materialize (barring the mother of all policy surprise this week) which will further undermine the credibility of these rates forecasts, but it remains a nice messaging device. The September version had the Fed-Funds in the 5-5.25% range at the end of 2024, implying only a 50-bps cut from the peak forecasted at the time. The Fed could maintain a ‘high for long’ message by keeping the same change in the policy rate from the actual end-2023 level, hence bringing it down to the 4.75%-5.0% at the end of 2024. Since it is a collection of individual forecasts, precise steering is not always possible, but the crux of the matter is that there would still be a significant gap between the Fed’s forecast and the market’s expected trajectory.

Acrobatic communication from the ECB

“We expect Christine Lagarde to follow a similar approach this week [as Isabel Schnabel in previous weeks] removing further hikes from the debate, but also calling for prudence in the face of impatient markets, stressing, as Schnabel did, that the next months’ inflation readings may be less spectacular,” Moëc explains.

He concurs with the ECB that headline inflation is unlikely to decline much more in year-on-year terms in the next few months ahead, as most of the powerful favorable base effects are now fading. Still, Moëc expects some small downward revision to the inflation forecasts for 2025 to 2.0%, from 2.1%, which would be consistent with a central bank increasingly confident it has done enough, but still far enough into the projection horizon to call the market for prudence in its pricing of cuts.

“Our baseline for the first cut remains June 2024, but the speed of disinflation – occurring faster than we expected – makes it plausible a cut intervenes earlier in Q2. Our point though is that we fail to see why the ECB would want to engage in this discussion right now. We think it is better off maintaining a steady course,” Moëc says.