Eddy's Weekly Market Update

For some time now, we've been indicating that economic growth in Europe and the US must remain below potential growth for inflation to structurally stay below 2%. Potential growth in the US is essentially around 1.8%, but due to high immigration this year, it's temporarily around 2.3%. In Europe, it's between 1% and 1.25%.

The big question is at what interest rate level growth will be pushed back to the desired level. As long as growth remains too high, monetary conditions need to be tightened. This means higher (real) long-term interest rates and credit spreads, a stronger dollar, lower stock prices, and downward pressure on (commercial) real estate prices.

Currently, the general feeling is that interest rates in Europe are high enough to keep growth below potential. That's why there's an expectation of a first interest rate cut of 0.25% by the ECB in June. It's important to note here that growth in Europe has been around 0% for some time. Only recently has growth picked up to around 1%. If growth remains at this level, there will be little room to further lower interest rates after June. We also expect that growth will not fall much in the coming period (see our recent reports), and we now anticipate a total of 2 to 3 interest rate cuts by the ECB during this year. We expect that this will lead to enough slowing of growth this year, allowing the interest rate to probably be lowered another 5 to 6 times next year.

This expectation is also influenced by the fact that we anticipate commodity prices to continue rising in the near future due to geopolitical tensions, insufficient investment in commodity production, and increasing demand due to the energy transition. This affects inflation negatively.

Looking at the US, earlier this year it was expected that the Fed would implement 6 to 7 interest rate cuts during this year. Something we immediately disagreed with. However, this expectation has now been significantly revised to 1 to 2 cuts. Inflation is decreasing slowly, and economic growth remains quite high. For example, the US economy grew by about 5% in the third quarter of last year and by about 3.5% in the fourth quarter. Then it seemed that growth in the first quarter of this year would be around 2.5% to 3%. However, yesterday's big surprise was that growth, according to the initial official estimate, was around 1.6%. Are interest rates in the US high enough then to sufficiently slow down growth? And does the Fed indeed have enough room to lower interest rates?

Unfortunately, the answer is negative. The slowdown in growth was mainly due to much less inventory buildup and deterioration in foreign trade. Two factors that are not likely to continue and are likely to reverse soon. This picture is also supported by inflation, which has not decreased but increased. ?

The conclusion is therefore that the US probably needs tighter monetary conditions to push growth more structurally below potential. In other words, there is little room for the Fed to lower interest rates, and there remains upward pressure on long-term interest rates. ?

By the way, this leads to further appreciation of the dollar against the Japanese Yen. However, the Yen is already 40% undervalued in terms of purchasing power parity, so further depreciation of the currency has more disadvantages than benefits. Our expectation is that there will soon be massive intervention to push the Yen's value up. This may temporarily push the euro-dollar exchange rate up and increase downward pressure on bonds and stocks.

A more detailed analysis of all of this is available in ECR's most recent Global Financial Markets Report. If you would like to receive a copy, feel free to send me a brief DM with your email address - happy to send it across to you.

Have a pleasant week ahead,

Kind regards,

Eddy