ECB Update: Piggybacking the Fed

Summary
       
• Everybody is still preoccupied with the finer details of inflation. That must be why almost no one has noticed that US unemployment is already past the point of no return. Only a full-blown Fed rate cut cycle can turn the tide and stabilize unemployment. Historically, the Fed cut rates aggressively when unemployment started to rise. Ongoing US disinflation means that we’re not looking at a re-run of the Volcker era, when the Fed had to ignore unemployment and focus on inflation.

• I expect Fed Chair Powell to do a clear-cut dovish pivot at Jackson Hole next month, setting the stage for the first rate cut in September. Powell & Co will follow through with consecutive rate cuts.

• Lagarde & Co will not want to miss the bus. The ECB will cut in September too. A cut that month is inevitable, given the narrowing of the interest rate corridor. Ongoing subpar growth of the Eurozone economy plus further disinflation will justify more cuts: in December and March. The ECB will lead the Fed with regards to cutting rates – for a while at least. In case of a full-blown recession, history has shown that the Fed always hits harder than the ECB. The roles will be reversed in that case.

• Since the risks are tilted toward a US recession – and thus more Fed cuts – the risks are also tilted toward a more aggressive ECB easing path than I have penciled in. The 100bps in ECB cuts that I forecast still put the deposit rate in restrictive territory. If the Fed goes all in because of a US recession, the ECB will have no choice but to piggy-back on the Fed’s rate cuts.