Keep Your Eye on Internationals

Dr. Jeffrey Roach | Chief Economist

Last Updated:

Key Takeaways

  • The timing of the first Federal Reserve (Fed) rate cut is in doubt as the domestic inflation outlook remains cloudy.
  • Investors with a domestic bias were rewarded as European business activity faltered while the U.S. economy boomed, but conditions may be changing this year.
  • Markets may have to reset global growth expectations with the latest Nowcasting results.

Rate Cut Expectations Affect Market Volatility

Markets are increasingly nervous that sticky inflation will derail expectations of the Fed cutting rates early this year. Despite uncertainty about near-term inflation, we don’t think the hot January consumer price report changes the narrative that inflation will decelerate throughout this year. As we often say, the path to lower inflation is likely not a straight line, but it should slope downward. But domestic inflation seems to be currently stickier than international prices.

The key investment takeaway from the global inflation story is that the European Central Bank (ECB) may pivot sooner than the Fed. Historically, the ECB plays “follow the leader” and waits for the Fed to move first, whether the Fed is raising rates, cutting rates, or pausing. During the last several business cycles, the Fed was the first to move, as illustrated in the chart below.

ECB Plays "Follow the Leader" with Fed

Federal Reserve is Often the First to Change Course
Line graph depicting European Central Bank's versus the United States' economic movements from 1999 to 2023 highlight that the EU follows the Federal Reserve.
Source: LPL Research, European Central Bank, Federal Reserve Board, 02/21/24

Call to Action

If inflation is convincingly decelerating faster in Europe than in the U.S., capital markets will likely experience a novelty — that is, the ECB leading the way in altering monetary policy. This could have ramifications on the dollar, global yields, and equity markets.

This year may be the year to seek out investment opportunities outside the U.S as well. The Strategic and Tactical Asset Allocation Committee (STAAC) favors U.S. equities over developed international due to a relatively stronger domestic economic growth outlook and superior earnings power, though the Committee still finds Japanese equities attractive. However, if the ECB adjusts policy sooner than markets expect and the Fed adjusts later than expected, then investors could experience a relative allocation opportunity. In markets like these, allocators often benefit with active managers able to manage variance among global markets. In short, investors should keep a watchful eye on internationals.

European Inflation Improving Faster than U.S.

Global Central Banks Find it Hard to be in Sync
Bar graph depicting European versus United States' inflation rates from 2020 to 2023 highlights European inflation improving faster than inflation in the U.S.
Source: LPL Research, Bureau of Labor Statistics, Statistical Office of the European Communities, 02/21/24

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Dr. Jeffrey Roach

Jeffrey Roach guides the overall view of the economy for LPL Financial Research and has over 20 years of experience in investing and economics.