ECB preview: data-driven until June, Fed-dependent thereafter.

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:

  • At this week’s meeting, the ECB might lay the groundwork for a potential rate cut in June.
  • The central bank's commitment to a data-dependent approach is expected to depreciate the euro currency further.
  • After the first interest rate cut, the prospect of a weaker euro currency may prompt the ECB to adjust its accommodative stance, pause, and align its monetary policies with the Federal Reserve's rate-cutting cycle.
  • Diverging ECB-Fed monetary policies are set to boost European sovereigns over U.S. peers.
  • We prefer the shorter end of the yield curve while remaining cautious about ultra-long bonds. A modest cutting cycle amidst an economic recovery suggests a potential twist-steepening of the yield curve, with shorter-term yields declining and longer-term yields increasing.

Falling Bunds highlight the ECB's monetary policy limits.

Although disinflation in the Eurozone has accelerated since the start of the year, 2-year Schatz yields have increased by 50 basis points, rising from 2.4% to 2.9%. Front-term yields are closely tied to policy rates, reflecting investor sentiment opposing expectations of an imminent aggressive interest rate-cutting cycle. In fact, at the beginning of January, bond futures were pricing 160 basis points of rate cuts for 2024, compared to 85 basis points today.

During the same period, 10-year bund yields increased from 2% to 2.4%. This is significant because the performance of the long end of the yield curve is less influenced by monetary policies and relies more on inflation expectations and the economy's overall shape.

Bunds might convey a powerful message: long-term yields might remain sticky amid market resilience. Indeed, signs of a Eurozone recovery are underway despite the ECB deposit facility rate remaining at 4%. Upcoming rate cuts might improve growth but weigh on the euro currency, increasing the risks of another wave of energy inflation, leading to a cautious approach by policymakers.

Source: Bloomberg.

The first interest rate cut will come in June, but a pause will follow.

Market consensus is that the upcoming European Central Bank (ECB) meeting will lay the groundwork for a potential rate cut in June. This expectation finds support in recent policymakers’ communications, which indicate a willingness to pivot toward normalizing monetary policy to a neutral stance as supply shocks continue to unwind.

The recent ECB Minutes confirmed the bias for a June rate cut: "(...)in addition to new staff projections, the Governing Council would have significantly more data and information by the June meeting, especially on wage dynamics. By contrast, the new information available in time for the April meeting would be much more limited, making it harder to be sufficiently confident about the sustainability of the disinflation process by then.

Consequently, market expectations have shifted from pricing in 40 basis point rate cuts by April at the beginning of the year to completely eliminating the chances of a rate cut this month and gradually adjusting forecasts for the rest of the year.

We concur with the anticipated rate cut in June, followed by a pause in July. However, three consecutive rate cuts in September, November, and December may not be justified if the Federal Reserve remains cautious.

Growth, Inflation, and Wages: The Delicate Balance of a June Rate Cut.

The ECB has expressed concerns regarding the sluggish decrease in services inflation, which indicates persistent inflationary pressures in specific segments of the economy that are more wage-sensitive. This "last mile" of inflation presents a challenge for the ECB, necessitating a careful approach to wage growth and policy adjustments to ensure that inflation expectations remain well-anchored within target.

Strong wage growth has contributed to domestic price pressures. Although wages seem to have peaked at the beginning of 2024, it makes sense that the central bank is looking for more indications that wages are normalizing before engaging in a rate-cutting cycle, especially in the context of improving growth.

Signs of economic activity bottoming out, coupled with slightly faster-than-expected easing of inflationary pressures, create a delicate balance for the ECB. The need to support growth without prematurely easing monetary conditions highlights the complexity of the timing and extent of the anticipated rate cuts.

Data-dependent now, Fed-dependent later.

While the ECB's decision to start a cutting cycle is mainly influenced by internal economic indicators and inflation trends, it is also affected by the global monetary policy environment, particularly the Federal Reserve's policy stance. Should the Federal Reserve delay its rate-cutting cycle, the ECB might find itself in a position where it has to moderate its own cutting cycle. This is primarily because a significant policy divergence could lead to a weaker euro relative to the dollar.

The Eurozone’s export-oriented growth model may benefit from a weaker euro, especially in light of the risks of new U.S. tariffs in case Donald Trump returns to the white house. However, since Europe imports a substantial amount of commodities priced in dollars, a weaker euro could inadvertently fuel inflation by increasing the cost of imports. This dynamic could compel the ECB to adopt a more cautious approach to rate cuts, aiming to balance the need to support growth while keeping a close eye on inflationary pressures that might arise from currency depreciation.

Why does the front part of the yield curve offer a win-win solution?

Because even in the remote event of a second inflation wave, investors holding 2-year sovereigns are unlikely to run losses, as yields on these tenors need to more than double, implying another aggressive interest rate equal in intensity to the one we just came out from. 

Other recent Fixed Income articles:

03_Apr Fixed income: Keep calm, seize the moment.
21-Mar FOMC bond takeaway: beware of ultra-long duration.
18-Mar Bank of England Preview: slight dovish shift in the MPC amid disinflationary trends.
18-Mar FOMC Preview: dot plot and quantitative tightening in focus.
12-Mar US Treasury auctions on the back of the US CPI might offer critical insights to investors.
07-Mar The Debt Management Office's Gilts Sales Matter More Than The Spring Budget.
05-Mar "Quantitative Tightening" or "Operation Twist" is coming up. What are the implications for bonds?
01-Mar The bond weekly wrap: slower than expected disinflation creates a floor for bond yields.
29-Feb ECB preview: European sovereign bond yields are likely to remain rangebound until the first rate cut.
27-Feb Defense bonds: risks and opportunities amid an uncertain geopolitical and macroeconomic environment.
23-Feb Two-year US Treasury notes offer an appealing entry point.
21-Feb Four reasons why the ECB keeps calm and cuts later.
14 Feb Higher CPI shows that rates volatility will remain elevated.
12 Feb Ultra-long sovereign issuance draws buy-the-dip demand but stakes are high.
06 Feb Technical Update - US 10-year Treasury yields resuming uptrend? US Treasury and Euro Bund futures testing key supports
05 Feb  The upcoming 30-year US Treasury auction might rattle markets
30 Jan BOE preview: BoE hold unlikely to last as inflation plummets
29 Jan FOMC preview: the Fed might be on hold, but easing is inevitable.
26 Jan The ECB holds rates: is the bond rally sustainable?
18 Jan The most infamous bond trade: the Austria century bond.
16 Jan European sovereigns: inflation, stagnation and the bumpy road to rate cuts in 2024.
10 Jan US Treasuries: where do we go from here?
09 Jan Quarterly Outlook: bonds on everybody’s lips.

Quarterly Outlook

01 /

  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Head of FX Strategy

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Head of FX Strategy

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
The Circle 38
CH-8058
Zürich-Flughafen
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved we have put together a general Risk Warning series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) Ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law. 

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.