ECB hawkish shift meets market resistance as Fed prepares another cautious cut
Markets
Monday’s ECB Schnabel driven rally in EMU yields ran into resistance yesterday. Investors in some way embraced her message that the next ECB move, after a period of rate stability, will likely be a rate hike. EMU money markets priced out the probability of a final fine-tuning/risk management cut next year and at the same time raise chances of higher rates from the turn of 2026/27 on. US markets are preparing for another ‘hawkish’ rate cut today despite ongoing pressure for the government to ease policy in a more aggressive way. Visibility on upcoming data-guidance remains low but yesterday’s rise in yields after better than expected JOLTS job openings data only illustrated market sensitivity to the topic. US yields added between 4 bps (2 & 5-y) and 0.6 bps (30-y). US yields are close to the top of the post-summer sideways technical trading ranges. A $39bn 10-y US Treasury auction delivered ‘neutral’ bidding metrics and had little impact. Equity markets took a pause with record levels back within reach. Changes in the intraday interest rate dynamics between the dollar and other currencies, including the euro, again lacked directional impact. DXY (close 99.22 from 99.08) gained marginally, mainly driven by a rebound in USD/JPY (close 156.9). EUR/USD softened slightly (close EUR/USD 1.1627). French Parliament yesterday approved the social security bill, removing an hurdle to get budget approved as soon as next week, but more likely early 2026. For now this French ‘muddling through’ scenario doesn’t help the euro.
The Bank of Canada (expected unchanged at 2.25%) and the Banco National do Brasil (expected unchanged at 15%) join the Fed in deciding on monetary policy today. The Fed is expected to proceed with another precautionary 25 bps rate cut (to 3.5%-3.75%) despite a highly divided MPC. Markets will keep a close eye at the new Summery of Economic Projections (dots) and any guidance from Fed Chair Powell. However, news from those sources will probably be highly conditional. Governors since the September forecast had little hard evidence on the labour market and even less on inflation to make substantial changes. One can expect the Fed chair to shift to an outright data-dependent narrative as the policy rate is coming closer to neutral. This puts the focus on data updates between now and Christmas (payrolls, CPI and Q3 GDP). With yields having rebounded/priced out more aggressive easing, there might again be room for some correction in case of softer data. However, question is whether today’s FOMC meeting will already allow for such a reaction. On FX, DXY and EUR/USD show little directional momentum. On the euro side of the equation, uncertainty on France and maybe even more on the outcome of negotiations to end the war in Ukraine are a drag for further euro gains.
News and views
Chinese inflation rebounded to 0.7% y/y from 0.2%, the quickest pace since February of last year. Food prices were partly responsible for the uptick, rising for the first time since January. Non-food inflation slipped to 0.8%. Filtering for both food and energy prices, core inflation ended a six-month acceleration streak to come in unchanged at 1.2%. Other elements supporting the inflation rebound were surging gold jewelry prices (+58.4% y/y) which lifted the category “miscellaneous goods and services” to 14.2% y/y. Services prices increased at a slower rate compared to October (0.7%), the first slowing since February. The above combined with producer prices unexpectedly showing steeper drops (-2.2% from -2.1% vs -2% expected) means the CPI rebound isn’t a solid sign of deflation risks structurally easing. The Chinese yuan gapped lower at the open this morning but meanwhile swapped losses into gains around USD/CNY 7.06, a more than one year CNY high.
BoE policymakers in yesterday’s parliamentary hearing largely stuck to their personal and mixed views on whether or not it is appropriate to further lower policy rates. One of them, however, offered a glimpse on the BoE’s judgement of the November budget. Deputy governor Lombardelli said it would lower the annual inflation rate by 0.4-0.5 ppts from 2026Q2 while lifting GDP slightly by 0.2 ppts in 2027. The budget together with inflation coming off again were seen as paving the way for a December rate cut. Lombardelli suggested, however, the BoE could look through the one-off impact on inflation from the government measures but added that the latter may help bring down elevated household inflation expectations. It will probably once again be BoE governor Bailey having the swing vote in next week’s policy decision.
Author
KBC Market Research Desk
KBC Bank
