Hello there,
Welcome to central bank week! Carmel is away, so I have the pleasure of writing this week’s update. We also brought forward our publication time by a day to preview the Federal Reserve, the European Central Bank and the Bank of Japan meetings.
The ultimate question of the week is this: are we simply enjoying the calm before the storm, or has the storm been cancelled due to lack of popular demand?
The Fed will undoubtedly cut rates today to counter some softness in the labour market, even if U.S. President Donald Trump continues to grumble that it’s too timid and too late. The central bank will also keep the door wide open to further easing, doing little to challenge market bets for another three or four cuts before the end of next year.
Stock investors couldn’t be happier. Cheaper borrowing costs and a relentless AI boom pushed all three major U.S. stock indexes to record closing highs this week, driven by OpenAI’s restructuring and by , which made the company the first worth $5 trillion.
Meanwhile, Trump just announced a trade breakthrough with South Korea while sounding optimistic ahead of a summit with Chinese President Xi Jinping, fuelling a further market rally.
Such a string of positive news has boosted risk-on sentiment and pushed down gold prices by around 10% in the past week, a level some see as still unreasonably high. Gold has been driven up by fears over erratic U.S. economic policy as funds leaving the dollar struggled to find other safe havens. But lower economic uncertainty should reduce demand and channel cash back into Treasuries or stocks.
Over in Europe, the ECB is in a pretty easy situation. It brought inflation back to target with almost no hit to the economy, the holy grail of central banking that neither the Fed nor the BOJ has yet achieved. It will keep rates on hold on Thursday in a well-telegraphed decision, and ECB President Christine Lagarde will continue her mantra that policy is in a "good place."
The Bank of Japan also has no reason to act, as there is little evidence that higher U.S. levies are hurting the economy, with exports rising and business confidence improving.
Still, global economic tranquility may be fragile.
Stocks have outperformed all expectations, but a long list of officials are already warning that valuations are out of line with fundamentals, raising the risk of a potentially sudden, disorderly correction. Large U.S. corrections frequently morph into recessions, with the U.S. exporting economic weakness around the globe.
Hopeful trade noise must also be taken with a grain of salt, given that U.S. policy could take a 180-degree turn at any given time with no warning, like in Canada's case. These sudden shifts make it impossible for firms to plan, and many are delaying investment, dampening growth.
The U.S. government shutdown presents hard-to-quantify risks. It will reduce growth, even if only temporarily. But more importantly, the shutdown affects economic data collection by government agencies, leaving the Fed to act partly on instinct.
This week is clearly risk-on, but the potential for a sudden turnaround is rising.
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