So many things happened this month that I struggled deciding what to include and what not to include in this newsletter: some weeks are so eventful that they feel like entire months of developments packed into a short time.
The highlights of the month include a patriotic acquisition of Commerzbank, some monetary surprises, and a big liquidity injection from China. We’ll go through these points one by one.
Finally, just a few days before this newsletter, we got a big geopolitical development: Israel invaded Lebanon too, and Iran launched missiles against the country. This newsletter is not about geopolitics, but the financial implications are clear—energy is likely to remain a long position, while risk-off currencies like the dollar and yen have rallied amidst the panic. Unsurprisingly, oil prices surged, lifting the energy sector along with them.
However, despite the talks, the immediate financial implications seem limited, at least until the US elections are out of the picture. After that, a Republican win will likely lead to a way softer stance on the genocide, and therefore increased tensions: this is probably the only reason why even conservatives may vote blue in November.
United States
From an economic standpoint, the observations made over the past few months about the United States remain valid. While it may seem repetitive to highlight these points each month, the reality is that the economy has remained stable, with little change in the interpretation of the data available. In general, the country continues to experience robust growth, with inflation either stable or declining (depending on the metric under focus), and unemployment at low levels. These three key macroeconomic indicators provide a reliable overview of any country’s economic health, and despite the pessimism from certain corners of the internet, the US economy has performed quite well lately.
From a market perspective, I maintain the view that there is a significant mispricing in the rate curve. I doubt the Federal Reserve will cut rates as aggressively or as quickly as currently priced, as such a move would require a sharp and rapid economic downturn—an event I don’t foresee in the near term. I will expand on this point later.
There have also been notable developments for certain companies, particularly with the Department of Justice initiating actions against Alphabet and Visa over alleged monopolistic practices. However, as I’ve noted before, this is actually a bullish signal. Indeed, when the government effectively admits that a company’s competitive moat is so formidable that breaking it up is the only way to restore competition, it underscores the strength of the business. Moreover, such investigations rarely lead to actual breakups, as evidenced by the Microsoft case in the past. Of course, I have taken advantage of this opportunity to build solid positions in both companies, with Alphabet now being among the five biggest positions in my portfolio.
Finally, as we approach the elections, their significance for the markets becomes increasingly clear. Rather than focusing on which candidate is preferable, the key is to analyze their proposed policies to anticipate market implications. While I’m not invested in the debate over who might be the better candidate, as I am not American, by looking at the campaign results it seems increasingly unlikely that Trump will win. The Republican Party might still have a strong chance if they were to change their candidate, but it appears to be too late for that. However, regardless of who is elected, the economic policies proposed are populist in nature and somewhat inflationary: the difference is that Harris’ spending-driven approach might be more directly inflationary, while Trump’s mix of tax cuts and tariffs could result in indirect inflation due to higher consumer prices and deficits. Regardless, under both candidates the US debt is set to continue rising. A good summary of the economic ideas of the candidates can be found here.
Therefore, my current post-election outlook anticipates a weaker dollar, continues strong performance in equities, and an acceleration in economic activity. More precisely, I expect the equity market to perform better if Trump is elected, just because of how much his proposed economic policies focus on the private-sector.
Federal Reserve
In September, the FOMC surprised many, myself included, by cutting rates by 50bps. However, it must be noted that markets had already started pricing in this scenario with high probability the week prior. What’s even more striking than the decision itself is how unanimous it was: with the exception of Governor Bowman, all members supported the 50bps cut.
At first glance, such a decision might suggest that something has gone wrong in the economy, possibly indicating that a recession is already here. However, the SEP told a very different story: real GDP is projected to grow by 2.0% annually over the foreseeable future, and both PCE and Core PCE inflation forecasts were revised lower. Although the unemployment rate is expected to peak at 4.4%, it is set to decline in the following years. Sure, this figure is higher than previous estimates, but it remains historically low.
Considering the Fed’s actions alongside its forward guidance, the only conclusion I can draw is that its framework has evolved: the “old Fed” was reactive, intervening to smooth out the business cycle, while the “new Fed” seems proactive, taking steps to extend the positive phase of the cycle for as long as possible. Mathematically speaking, the “old Fed” affected the amplitude of the curve, while the “new Fed” is affecting its periodicity. This approach has clear advantages, but it also carries risks—particularly the risk of capital misallocation, a downside that became evident during the NIRP era. I’m not a fan of purely theoretical economics, but aggressively intervening in an attempt to only highlight the bright spots rarely leads to success. One can only hope this time will be the exception.
Regardless, from an economic standpoint, the difference between 50+25 and 25+50 is negligible; however, the psychological impact of the former tends to be more optimistic. And if you expect to see another 50bps cut this year, think again: it would require a significant contraction in either the labor market or economic growth for the Fed to even consider such a large move in the near future.
Looking ahead, the FOMC revised its 2024 rate forecast down to 4.4% from 5.1%, signaling an additional 50bps worth of cuts by year-end. Moreover, the median projections now show the 2025 rate at 3.4% (down from 4.1%) and the 2026 rate at 2.9% (vs 3.1% previously), which aligns with their view of the neutral rate, now revised slightly higher to 2.9% (from 2.8%)
The statement saw some adjustments as well: it acknowledged that inflation has made further progress but remains somewhat elevated. It also expressed increased confidence that inflation is moving sustainably toward the 2% target and assessed that risks to achieving its goals are now more balanced. However, the guidance remained unchanged, stating that the Committee will “carefully assess incoming data, the evolving outlook, and the balance of risks.” Importantly, it reaffirmed its strong commitment to “supporting maximum employment” and bringing inflation back to its 2% objective.
Then, at the post-meeting press conference, Powell emphasized that the central bank is not committed to any predetermined path, and will make decisions on a meeting-by-meeting basis. Regarding the 50bps rate cut specifically, he mentioned that a range of data—including recent labor market revisions—suggests possible downward adjustments to payroll numbers. We discussed these in the previous update. Despite these revisions, Powell maintained that the Fed remains optimistic about economic growth, citing strong retail sales and robust Q2 GDP figures. He also noted that current labor market conditions remain favorable, with low unemployment, high participation, and moderate wage growth.
On the subject of inflation, Powell reaffirmed the Fed’s commitment to reaching its 2% target, and dismissed concerns that the Fed is lagging behind the curve, pointing to its more measured approach compared to other central banks. He also suggested that the neutral rate is likely higher than pre-pandemic levels, a point I too argued in May and June.
Europe
On September 9th, just two days after my birthday, Draghi presented his report “The Future of European Competitiveness“, a 400-page document, ordered by the president of the European Commission Ursula von der Leyen. Its publication follows closely on the heels of the Letta report, authored by another former Italian prime minister, Enrico Letta, which proposed significant changes to the EU’s internal market. However, Draghi’s text is far more strategic and ambitious, addressing three key challenges for the European Union: closing the innovation gap with the United States, harmonizing decarbonization with competitiveness, and enhancing economic security by reducing dependencies.
Draghi emphasizes that Europe’s economic model has significant shortcomings, particularly regarding investment. Indeed, the continent growth has suffered since the 2008 financial crisis due to austerity and a lack of EU fiscal capacity, compounded by a fragmented capital market—a point previously highlighted by George Soros in his book “The Tragedy of the European Union“.
- Innovation: Draghi acknowledges Europe’s strong innovation potential but notes that over a third of corporate unicorns relocate abroad due to regulatory and financial barriers. Proposed solutions include establishing a European Advanced Research Projects Agency (ARPA), incentivizing seed capital, reforming pension regulations to boost investments, and simplifying the R&D framework.
- Decarbonization and competitiveness: Draghi argues that Europe must align its decarbonization efforts with competitiveness. Higher energy costs threaten European firms, and mishandling decarbonization could worsen this gap. He recommends reforming the European electricity market and promoting industrial policies for clean technologies to ensure consumers benefit from decarbonization.
- Defense industry: The report highlights the inefficiencies in Europe’s fragmented defense sector, with up to 80% of procurement occurring outside the EU. Draghi calls for increased EU funding and the establishment of an EU Defense Industry Authority to consolidate demand and improve economies of scale, alongside a “buy European” policy that may concern US contractors.
- Economic security: Finally, Draghi stresses the need for greater economic security to reduce vulnerability to external pressures. This includes increasing defense spending, building a self-sufficient defense industry, and securing critical raw materials. While he acknowledges the costs, he suggests mitigating them through cooperation and trade agreements with non-EU countries, advocating for free trade as a means of enhancing security.
Under Draghi’s proposal, Europe requires over €800 billion in annual investments, roughly 5% of its GDP. While many economists support this figure, the challenge lies in whether sufficient viable projects exist to absorb this funding. The main concern is that while the report provides valuable proposals, these may be overshadowed by ongoing debates about joint financing and Eurobonds, which face opposition, particularly from Germany.
As Europe grapples with the strategic challenges laid out in Draghi’s report, the financial sector is not without its own turbulence. Indeed, Andrea Orcel, CEO of Unicredit, sent shockwaves through Germany by first announcing a 9% stake in Commerzbank, and then increasing it to 21%.
Orcel leveraged a loophole in the rules governing bank ownership, which require the ECB approval for acquisitions over 10%, but place no restriction on building economic exposure through financial derivatives like TRS. This allows Unicredit to economically position itself as the largest shareholder, outpacing even the German government’s stake. In other words, this is the modern equivalent of Giulio Cesare building the greatest empire ever constructed.
The fun part is that Orcel’s tactics have made it increasingly difficult for other potential bidders, like Deutsche Bank and BNP, to compete, as a substantial portion of Commerzbank’s shares is now tied up: with around 33% of the bank’s market capitalization controlled by the government and Unicredit, rivals face significant barriers to mounting a counteroffer.
While Orcel’s stake-building reflects a bold and strategic approach, it has also raised concerns regarding its political implications. Nevertheless, this move can be seen as a form of retribution for the “PIIGS” label from a decade ago, and as they say, all is fair in love and brostep.
European Central Bank
As expected, the ECB chose to cut the deposit rate by 25bps from 3.75% to 3.5%, whilst also lowering the main refinancing and marginal lending rates by 60bps as previously announced in March. In the policy statement, the ECB reiterated that it will continue to follow a meeting-by-meeting approach, and remain in data dependent mode. Furthermore, policy rates will be kept sufficiently restrictive for as long as necessary and the ECB will not pre-commit to a specific rate path.
In the accompanying macro projections, headline inflation forecasts for 2024-2026 were left unchanged, with 2026 remaining below target at 1.9%. On a core basis, 2024 and 2025 were upgraded by 10bps on account of stubborn services inflation. From a growth perspective, 2024-2026 projections were lowered by 10bps each “owing to a weaker contribution from domestic demand over the next few quarters”.
At the follow-up press conference, Lagarde noted that the decision to cut by 25bps was “unanimous”. On the inflation front, she noted that September inflation was likely to see a downtick on account of base effects before rising again in the fourth quarter.
Despite the many attempts by journalists to extract information about easing intentions for the October meeting, Lagarde states she would neither commit to a position or comment on how close the ECB is to R. For the ones interested in the debate, I made a poll on Twitter to estimate Europe’s R.
Nonetheless, sources from Bloomberg indicated that a rate cut in October is unlikely, although it remains a possibility. Due to the downside risks to economic growth in the Eurozone, officials prefer to keep the option of lowering borrowing costs open. Similarly, Reuters sources suggested that any decision before December would depend on unusually negative growth surprises. In fact, with little new information expected between September’s meeting and the next one on October 17th, it seems prudent for the central bank to wait for updated projections in December.
United Kingdom
As expected, the MPC opted to maintain the Base Rate at 5.0%, after implementing a 25bps cut in the previous meeting: the decision to keep policy settings unchanged was reached by an 8-1 vote, with Dhingra as the sole dissenter advocating for a rate cut. Among those who supported holding the rate steady, opinions varied on the extend to which the unwinding of prior global shocks, the normalization of inflation expectations, and the current restrictive policy stance would impact domestic inflationary pressures.
Regardless, most committee members indicated that “in the absence of material developments, a gradual approach to removing policy restraint would be warranted”. This sentiment was then reiterated by Governor Bailey, who cautioned that the MPC should avoid making rapid or excessive rate cuts. Additionally, the policy statement reaffirmed that policy “will need to continue to remain restrictive for sufficiently long”.
In conjunction with the rate decision, the MPC unanimously agreed to reduce the stock of Gilts by £100 billion between October 2024 and September 2025, as anticipated. Interestingly, the BoE did not include sales of 1-3 year maturity Gilts in this plan. Overall, the tone of the policy statement conveyed a sense of caution, with the MPC remaining firmly in data-dependent mode, similar to other central banks currently.
Following the meeting, Governor Bailey expressed optimism about the potential for further declines in UK interest rates, though he stressed the need for additional evidence. He also underscored the importance of eliminating residual inflation pressures, and emphasized that improving the UK’s potential growth rate of 1.2-1.3% is crucial. Regarding quantitative tightening, Bailey stated he is “very relaxed” about the government’s decisions concerning QT under fiscal rules, asserting that it will not influence BoE policy.
Japan
The BoJ decided to maintain its short-term policy rate at 0.25%, a move that was widely expected and achieved through an unanimous vote. The central bank outlined its expectation that inflation will generally align with its target during the latter half of its three-year projection period, extending through fiscal 2026. Furthermore, the BoJ indicated a notable increase in medium- and long-term inflation expectations. The central bank also highlighted the growing influence of exchange rate trends on pricing dynamics, suggesting that fluctuations in the yen may play a more significant role in shaping Japan’s inflation landscape. Finally, despite projecting that Japan’s economy is likely to grow above its potential, the BoJ cautioned about the potential impacts of volatility in financial and FX markets on domestic economic stability and inflation.
Governor Ueda’s post-meeting press conference attracted considerable attention, particularly due to his distinctly dovish and cautious tone. During this session, he emphasized the importance of international economies, especially the US, in the light of the Fed’s recent 50bps rate cut. One of Ueda’s key remarks was that recent foreign exchange developments have mitigated upside price risks, indicating a diminished likelihood of an inflation overshoot. Throughout the press conference, Ueda consistently referred to current market conditions as unstable, echoing Deputy Governor Uchida’s earlier comments from August 7th and reinforcing the BoJ’s commitment to refrain from raising rates amidst market uncertainties.
Overall, between Ueda’s characterization of current market conditions and the reduced upside risks to inflation, the bar to continue hiking “aggressively” (for Japan) is now higher.
Looking ahead, Shigeru Ishiba, the former Defense Minister, is set to assume the role of prime minister. His support for the normalization of BoJ policies and potential interest rate hikes stands in stark contrast to the pre-election front-runner, Takaichi, who was the only candidate advocating for the continuation of Abenomics—a strategy characterized by the aggressive purchase of JGBs and no rate hikes. The implciations of this political shift are clear: the yen is likely to strengthen. While this political event may not sufficiently counterbalance existing rate differentials and prevailing momentum factors, it certainly serves to mitigate potential downside risks for the currency.
China
China recently unveiled a stimulus package designed to inject liquidity, stimulate consumer spending, and revive the struggling real estate sector. Unsurprisingly, the markets reacted swiftly, with the Hang Seng Index surging over 15% on the day of the announcement.
The package revolves around three core elements. First, it boosts liquidity by cutting the baseline interest rate by 20bps, reducing mortgage rates by 50bps, and slashing commercial banks’ required reserve ratio by 50bps. Second, it aims to breathe life into the real estate sector by lowering minimum down payments on new home purchases, while local governments are set to roll out additional measures to stoke demand. Lastly, more fiscal measures are expected, likely targeting low-income households and families with young children through direct cash transfers.
The market’s reaction signals confidence in the government’s willingness to step up. This has fueled hopes for a meaningful economic rebound in Q4 2024 and into 2025. But the real question is whether this renewed optimism will translate into real-world outcomes: stronger consumer confidence, increased private and state investment, and a resurgence in foreign direct investment.
Should the stimulus prove effective, economies like Australia and South Korea stand to gain the most. If the real estate sector picks up, Australia could see heightened demand for iron ore and other raw materials. Likewise, an uptick in Chinese consumption could benefit countries that cater to luxury demand and tourism, such as France and Italy—especially as we approach Chinese New Year in January.