The task facing central banks over the coming months will not be an easy one. On the one hand, inflation risks are rising; on the other, growth forecasts continue to be revised downward.
The European Central Bank (ECB) has provided fairly extensive guidance on its reaction function through recent remarks by Lagarde, Schnabel and Lane. In essence, this reaction function can be summarized as follows: as long as fiscal responses from governments remain contained, which has been the case so far, interest rates are likely to move only marginally higher. The rationale behind this communication is straightforward: economic growth remains too weak for the economy to absorb a supply shock such as the one currently unfolding. We will not revisit here the indicators supporting this view, but broadly speaking, we share the ECB’s assessment. This underpins our constructive positioning on short and medium-term government bonds in the euro area.
In the United States, the reaction function appears far less clear. This is unsurprising, given that Warsh, the new Chair of the Federal Reserve (Fed), has so far spoken very little publicly. Over the past year, the Republican administration has sought to influence Fed monetary policy as directly as possible, and Warsh’s appointment is consistent with this approach. On paper, his mandate is to lower interest rates. Unfortunately for him, he may find himself relatively isolated within the Board following the failed attempts to undermine Jerome Powell and Lisa Cook. More importantly, macroeconomic data provide little justification for rate cuts; quite the opposite. The labor market in particular, viewed by the Fed as the key source of risk over the past two years, is now broadly balanced and close to full employment. The Dallas Fed recently published a study (Break-even employment declines as unauthorized immigration outflows continue - Dallasfed.org) concluding that, due to immigration policies and the structural decline in labor force participation, the number of jobs required to prevent unemployment from rising may now be close to zero. Meanwhile, economic conditions in the United States remain broadly resilient. The U.S. economy has been significantly less affected than others by the conflict in Iran and continues to benefit from the boom in AI-related investment, which is boosting U.S. growth relative to other major economies.
Viewed objectively, current U.S. data arguably support the case for higher short-term interest rates: an unemployment rate holding steady at 4.2% (as of end-April), robust consumption growth of 5.7% year-over-year (end-April), nominal growth exceeding 6% (end-March) and market-implied inflation expectations above 3.5% (as of May 21) through March 2027. In our view, risks therefore appear greater today in U.S. rates than in euro area rates, which could ultimately support further appreciation of the U.S. dollar against the euro.
Naturally, much will depend on developments in the conflict with Iran and commodity prices. However, without a meaningful improvement in the coming months, Mr. Warsh’s task appears particularly challenging.
Source: Bloomberg
This commentary is provided for information purposes only. The opinions expressed by Crédit Mutuel Asset Management are based on current market conditions and are subject to change without notice. These opinions may differ from those of other investment professionals. Published by La Française Finance Services, head office located at 128 boulevard Raspail, 75006 Paris, France, a company regulated by the Autorité de Contrôle Prudentiel as an investment services provider, no. 18673 X, a subsidiary of La Française. Crédit Mutuel Asset Management: 128 Boulevard Raspail, 75006 Paris is an asset management company approved by the Autorité des marchés financiers under n° GP 97 138 and registered with ORIAS (www.orias.fr) under no. 25003045 since 11/04/2025. Public Limited Company (Société Anonyme) with share capital of €3,871,680, RCS Paris n° 388 555 021, Crédit Mutuel Asset Management is a subsidiary of Groupe La Française, the asset management holding company of Crédit Mutuel Alliance Fédérale.
