More rate cuts to come – But only in the US
|Over the past month, concerns about the condition of the US labour market have fuelled expectations of further rate cuts from the Federal Reserve (Fed). However, a continued robust US economy has eased recession concerns, boosting investor risk appetite and equity prices. The prospect of monetary policy easing has also pushed long-end US rates lower, with debt concerns taking a back seat for now. In contrast, upward pressure on short-end European rates has persisted through August and September, with 2-year EUR swap rates rising by approximately 5bp over the past month, supported by the ECB’s continued hawkish rhetoric. The long end of the curve, however, has edged slightly lower, influenced by movements in US rates, leading to a so-called 'twist' flattening of the yield curve.
Additional rate cuts expected in the US
As expected, the Fed cut its policy rate by 0.25 percentage points at its latest meeting in September, making it the first rate adjustment since December 2024. The Fed's median expectation is for two additional 0.25 percentage point cuts this year, a more aggressive stance than previously signalled, suggesting that rate reductions will come in steady succession. However, there is significant disagreement within the committee between those advocating for substantial monetary easing and those concerned about the prospect of rising inflation. President Trump’s political agenda of lowering US rates has increasingly brought the political situation in the US, including concerns over the Fed’s independence, into focus as a market theme.
While we believe that the labour market weakening justifies monetary policy easing, we think that markets are underestimating the risk of inflation fears resurfacing. Inflation driven by tariff increases has largely been absorbed within corporate margins so far, but we see a clear risk of this changing later in the autumn. We expect the central bank to deliver a total of four additional 0.25 percentage point rate cuts by late summer 2026, representing a more gradual monetary policy easing than the market currently anticipates.
ECB is in a ‘good place’
After a summer of encouraging trade policy developments, including a trade agreement between the US and the EU, improvements in economic indicators, and signs of accelerated fiscal easing in Germany, the ECB kept its key interest rates unchanged in September, as expected. In its updated forecasts, the ECB slightly downgraded its inflation forecast, now projecting headline and core inflation to remain just below 2% by the end of the forecast horizon in 2027. However, ECB President Lagarde downplayed the significance of the recent downward revision, repeatedly emphasising that the ECB is ‘in a good place’. Additionally, for the first time since September 2023, Lagarde highlighted that the ECB now views risks to the growth outlook as balanced, rather than tilted to the downside. In our view, the likelihood of further rate cuts from the ECB has declined further over the past month. We thus expect the key policy rate to remain at 2% until the end of 2026.
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