By Naomi Rovnick
LONDON (Reuters) – Feverish speculation over future interest rate cuts has further eased global financial conditions, posing risks to euphoric stock and bond markets as central banks see the easy funding environment as a reason to keep borrowing costs high.
Global financial conditions, considered a leading indicator of economic performance, are now the most accommodative since early August, a widely followed index from Goldman Sachs showed on Friday.
The index, which broadly tracks corporate borrowing costs and shows how easily companies can use stock markets for financing, remains close to its March 2022 level. That was just before the U.S. Federal Reserve, the European Central Bank and others Major central banks launched aggressive monetary tightening campaigns to bring inflation under control.
Goldman's U.S. version of this index shows conditions were the most accommodative since July 26.
The easing in financial markets reflects pricing in significant interest rate cuts next year that would undo some of central banks' recent monetary tightening, which in turn could encourage policymakers to keep borrowing costs high for longer than markets expect.
“You've priced in a lot of monetary easing, you're already getting easier financial conditions,” said Dario Perkins, global head of macro at TS Lombard.
If central banks “do not confirm these steps, if they do not lower interest rates and simply ignore them, then financial conditions will tighten again.”
Global stocks are up nearly 4% this month after rising more than 9% in November in a rally fueled by bets on interest rate cuts.
The Dow Jones Industrial Average hit its second straight record high on Thursday, European stocks are near their highest in nearly two years and Asia-Pacific stocks outside Japan hit four-month highs on Friday.
After Fed officials predicted on Wednesday that the world's most influential central bank would cut interest rates by 75 basis points (bps) this year from a current 22-year high, markets increased their rate cut bets, now pricing at nearly 150 bps. a cuts.
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Similar deep cuts are expected from the European Central Bank, which tried to dismiss this speculation on Thursday.
Money markets are also pricing in around 150 basis points worth of interest rate cuts from the European Central Bank next year, up from around 135 basis points on Wednesday, although the ECB tried to dismiss that speculation on Thursday.
“We may be in a situation where financial conditions have eased so quickly and significantly that this could have a significant impact on future growth and inflation,” Rabobank strategists said in a note.
Emmanuel Cau, head of European equity strategy at Barclays, said “many investors” among the hundreds he met recently had “heavy expectations for central banks to cut interest rates as much as expected.”
“It’s difficult to chase the (stock) rally at current levels,” he said.
(Reporting by Naomi Rovnick; Editing by Dhara Ranasinghe and Sharon Singleton)
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