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The Week at a Glance – The battle of R-star?

Markets have a hard time figuring out where the neutral rate is in the US and its peers, which leaves interesting opportunities in Fixed Income as we enter 2025. Are markets right that neutral rates can be widely different in a global economy?
2024-12-16

Morning from Copenhagen.

A big central bank week lies ahead, with the Fed (Wednesday), BoE (Thursday), and BoJ (Friday) all announcing their interest rate decisions. These are likely the final major macro events of 2024 that could meaningfully shift markets—making them critical to watch before we all take a well-deserved break. Here’s where market expectations stand going into the meetings:

  • 93.4% chance of a Fed cut
  • 8.5% chance of a BoE cut
  • 15.2% chance of a BoJ hike

Markets are essentially pricing a Fed cut while expecting the BoE and BoJ to remain on pause. So why did USD rates rally last week?

The answer lies in a mix of factors, most notably concerns that easing financial conditions in the US may reignite inflationary pressures. Markets have started to price in the risk of inflation re-accelerating.

Is this justified? Probably not to the extent we’re seeing, given weak momentum in China and the fact that the recent uptick is primarily in goods inflation—which comprises only 35% of the US CPI basket. By contrast, goods make up 50-55% of the UK/EZ CPI baskets, suggesting that EUR rates might be the better play if goods inflation rises further.

Chart 1: Goods inflation weighs far less on US CPI relative to peers

Markets have a hard time figuring out where the neutral rate is in the US and its peers, which leaves interesting opportunities in Fixed Income as we enter 2025. Are markets right that neutral rates can be widely different in a global economy?

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