Key takeaways from COP28 and recent central bank meetings

Executive summary:

• Fed officials projected three rate cuts in 2024 at their December meeting
• The Bank of England signalled that monetary policy will likely stay restrictive for some time 
• World leaders reached an agreement at COP28 to transition away from fossil fuels

On the latest edition of Market Week in Review, Investment Strategist Alex Cousley and ESG and Active Ownership Analyst Elizabeth Jackson discussed the latest monetary policy decisions from the U.S. Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of England (BoE). They also chatted about the key takeaways from COP28, which concluded in Dubai on 12 December.

U.S. Fed keeps rates unchanged but pencils in cuts next year

Jackson and Cousley opened the conversation by reviewing the highlights from the Fed's final policy meeting of 2023, held 12-13 December. Cousley noted that the U.S. central bank kept interest rates on hold as expected, leaving its overnight rate at a 22 year high of 5.25%-5.5%. The bigger surprise, he said, was the Fed's shift to a slightly more dovish monetary policy stance, which was hinted at in FOMC (Federal Open Market Committee) members' so called dot plot projections. "These projections revealed that FOMC members now expect three rate cuts next year, which is an increase from earlier forecasts. In addition, remarks by Chair Jerome Powell at the ensuing press conference showed that the Fed is shifting some of its rhetoric around the risks of tight monetary policy," Cousley stated.

He explained that up until recently, the Fed had been hyper focused on preventing a repeat of the mistakes it made during the era of high inflation in the 1970s and early 1980s. Back then, the central bank moved too quickly to cut rates once consumer prices started declining, which resulted in a rapid reacceleration in inflation, Cousley explained.

"As a result, for most of this year, the Fed has been citing the mistakes of the 1970s as a reason for being extra cautious when considering rate cuts. But this time, Chair Powell highlighted that the risks of tight monetary policy are two sided in that big problems can also arise from leaving rates too high for too long," he said. Cousley noted that bond markets reacted strongly to the Fed chair's comments, with yields on the 2 year, 5 year and 10 year Treasury notes plunging significantly as prices rose.

Importantly, Cousley said that even after the rally, he still thinks government bonds look attractive in terms of valuations. With recession risks still appearing elevated, he believes that the Fed could deliver more rate cuts than markets are currently pricing for next year. "All in all, I'd say that government bonds still play a pretty attractive role in multi-asset portfolios," he remarked.

ECB, BoE signal plans to keep monetary policy restrictive for some time

Shifting to Europe, Jackson noted that both the ECB and the BoE also left rates unchanged at their respective policy meetings the week of 11 December. Cousley said the key takeaway from the meetings was that both banks expressed more caution around potential rate cuts in 2024, especially in comparison to the Fed.

"ECB President Christine Lagarde, for instance, stated that bank officials didn't discuss rate cuts at all during their 14 December meeting, while the BoE specifically noted that monetary policy will need to remain restrictive for a bit longer," he explained.

Cousley said that both banks' stances are fairly understandable, given that the ECB and the BoE have lagged the Fed in terms of tightening. He said he expects both banks to also lag the U.S. when it comes to easing, noting that the ECB and the BoE are both a couple of months behind the U.S. in monetary policy trends.

Highlights from COP28

The conversation turned to COP28, with Jackson providing an overview and insights from the annual global climate change conference held by the United Nations. She said that approximately 100,000 individuals, including world leaders from about 200 countries, came together for this year's conference, which was held in Dubai from 30 November-12 December.

One of the key takeaways from COP28 was an agreement among the nearly 200 countries to transition away from fossil fuels and triple renewable energy capacity by 2030, Jackson said. "Many are taking this pact as a signal that the fossil fuel era is beginning to wind down as the world moves to decarbonise the global economy," she stated.

Jackson said if countries stick to the deal, it will have long term impacts on the word's various market economies. "Renewables and energy efficiency technologies have already proven they can be competitive and scalable in their own right. So, if countries can work to implement the COP28 agreement, we can expect to see an increase in investment in renewables, and potentially even more policy deals like the Inflation Reduction Act in the U.S., which provides benefits for companies and investors alike as they decarbonise the economy," she concluded.

Editor's note: There will be no Market Week in Review on 22 December and 29 December due to the end-of-year holidays. Market Week in Review will return on Friday, 5 January.