Foot off the gas ...

Foot off the gas ... now seems to be the motto of the American Federal Reserve. You may now be asking yourself: What do I mean by that? The American Federal Reserve (FED) already started lowering the key interest rates in September this year, first by 50 basis points and then again by 25 basis points in November (incidentally, two days after the election of Donald Trump as the next US President), with further rate cuts announced. However, we expect the pace of key interest rate cuts to slow down significantly in the coming months. Thus, the current picture priced in by the capital market is quite different from two months ago: In September this year, a key interest rate of below 3% was expected for December 2025. Meanwhile, we are now looking at expectations of just under 4% for the end of 2025, almost 100 basis points higher (source: Bloomberg, 22.11.2024). Rate cuts are still expected, but by no means to the same extent. We estimate between three and four rate cuts totaling 75 to 100 basis points over the course of the next year.

The last meters are the longest

What are the reasons behind this development? Let's first take a look at the inflation rates in the USA, which are fortunately significantly lower than 24 months ago, but have slowed down considerably over the last 12 months. The last meters (perhaps it’s even a bit more than just a few meters) seem to be the most arduous. Thus, consumer inflation year-on-year at the end of October has indeed decreased from 3.2% to 2.6%, but compared to the previous month – inflation from September 2023 to September 2024 – it has risen from 2.4% to 2.6%. If we look at core inflation (excluding food and energy), the picture looks even worse. The decrease from October 2023 to October 2024 by 0.7 percentage points from 4.0% to 3.3% (source: Bloomberg, 22.11.2024) is slightly higher, but still at a significantly higher level and still a way off from the magical 2% mark, which is the actual target of the US Federal Reserve. It is therefore not surprising that key interest rate expectations have shifted upwards again. Many also speak of "sticky inflation" – a stubborn, persistent, and ongoing price increase that has taken hold in the minds of economic actors (consumers, employees, and employers) and is therefore so difficult to combat by adjusting key interest rates without sliding into a central bank-induced recession.

Trump's re-election and yields

And then there was something else, wasn't there? On November 5, 2024, Donald J. Trump was re-elected as the designated 47th President of the USA. Moreover, that was not all: The Republicans also hold the majority in the Senate and the House of Representatives: Goodbye debt ceiling! The dispute between Democrats and Republicans over raising the debt ceiling has thus come to an end for now, as the approval of the Democrats is no longer needed, at least until the "midterm" elections in two years. There is therefore practically nothing standing in the way of a broad-based tax cut, whoever it benefits. The financing will be done by increasing national debt. This is the assumption in the capital markets. Consequently, the yields on US government bonds with a maturity of one year or more have risen again, reinforcing the trend of rising yields since the first rate cut in September. Ten-year bonds have risen by 69 basis points from 3.7% to 4.4% since the rate decision in September (source: Bloomberg, 22.11.2024). There has only been one rate-cutting cycle since 1970 in which the rate increase in the first three months thereafter was higher, and that was in the early 1980s. On average, the yields on ten-year government bonds have risen by only 7 basis points after a rate cut since 1970 (source: NDR, 22.11.2024). This marked and extraordinary increase in this rate cycle has therefore prompted Kathrein to slightly shorten the average maturity in the funds managed by Kathrein with USD bonds and thus reduce the interest rate risk.

Transatlantic interest rate differences

Recession fears in the USA have receded into the distance for now. The economy continues to grow, and Trump will do everything fiscally to ensure that this remains the case. Inflation is indeed above 2%, but still at a low level and not comparable to the inflation rates of the 1970s and 1980s. Last but not least, the US dollar remains well supported by the growing interest rate differential with the euro. Kathrein is therefore currently overweighting the US dollar in portfolios. Key interest rates and capital market rates are lower in the euro area, and we believe this difference will widen further next year. Currently, the yields on ten-year US government bonds are 4.4%, 215 basis points – over 2% – higher than those of German government bonds with the same maturity (source: Bloomberg, 22.11.2024). And this at a time when Germany is not shining with political stability.

This information represents a market overview and the market opinion of Kathrein. It does not constitute financial analysis and does not include any direct or indirect recommendation for the purchase or sale of securities or an investment strategy. When investing in securities, price fluctuations and thus capital losses are always possible. Information and representations of past performance do not provide reliable indications for future results. Despite careful research, no guarantee can be given for the accuracy of the data used here.