ECB rate cuts approaching

A backdrop of geopolitical unrest in the Middle East, rising commodity prices and surprisingly strong US data have fuelled rising yields across the globe in the past month. Shifts in US yields remain the decisive factor for developments. In the space of just one month, the benchmark US 10Y Treasury yield has increased from 4.30% to 4.60%, triggering memories of last autumn, when the same yield peaked a tad above 5%.

That being said, we assess the current dynamic to be different to that prevailing in the autumn in several ways. Firstly, the term premium on long yields – compensation for holding long versus short bonds – has remained largely unchanged in recent months, in contrast to the autumn, when investor fears over the rapidly growing US government debt contributed to pushing the premium higher, which had a knock-on effect on Europe. While the risk of yet another boost to the bond market’s ‘risk premium’ cannot be ruled out, we are generally not expecting any major shifts in the short term.

Our view is that yield increases will soon come to a stop and that the now very elevated expectations for growth and inflation in the US have raised the probability of an imminent decline in yields. The pendulum has simply swung too far.

ECB ready to cut interest rates in June – and the Fed will not change that

European yields have experienced a knock-on effect from rising US yields, which in midApril briefly sent the 10Y Bund yield above 2.5%. In contrast to the US, however, markets have had no real reason to doubt that rate cuts are approaching. At its April meeting, the ECB explicitly signalled an upcoming easing of monetary policy (read June), with the one caveat that labour market, inflation and growth data continue to develop roughly as expected. We assess there to now be a very strong internal consensus in the ECB for a 0.25 percentage point rate cut in June, so the next big question is just how quickly subsequent easings will unfold.

And here uncertainty remains high. Inflation in Europe continues to fall (2.4% y/y in March), but domestically driven inflation remains unduly high at 4.4% y/y in March. What the ECB lacks here is clarity on whether Europe’s high level of wage growth will be absorbed by corporate profit margins or, alternatively, if companies will instead pass rising costs on to consumers. The continuing uncertainty on underlying inflationary pressures in the eurozone may determine whether the ECB opts to proceed with greater caution on rate cuts after June. Our main scenario is that rate cuts will come at a 0.25 percentage points per quarter pace at the meetings in September, December and likewise in 2025. In our eyes, the risk is that the pace slackens.

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