Normalisation post banking turmoil

Danske Research Team Danske Bank A/S

The banking turmoil that erupted in the wake of the collapse of Silicon Valley Bank (SVB) five weeks ago has subsided as a market theme as the string of negative news has come to a halt. As a result, with traditional stress indicators declining, the focus has increasingly moved to the macro narrative, as we also discussed in our previous Yield Outlook - Uncertainty about US banking sector clouds rate outlook, 20 March.

The ‘normalisation’ of the rate outlook means that markets are currently trading two major themes which we also expect to set the tone for rates markets in coming months. While ‘Dollar Land’ is already discussing the first US rate cut, we expect the Federal Reserve to deliver a final 25bp rate hike at the upcoming May meeting and then to keep policy rates unchanged until Q1 24, when a gradual rate cutting cycle will likely commence. As regards the eurozone, discussions about rate cuts are still premature. We continue to expect a further string of rate hikes, with a 50bp hike in May followed by 25bp hikes in both June and July, bringing the peak policy rate to 4%. This is somewhat above the current market pricing of a 3.75% peak policy rate. The biggest risk to our forecast of a 4% peak policy rate hike is whether the ECB will deliver a 25bp or a 50bp rate hike in May. Markets are currently pricing 32bp for May. The economic backdrop for our central bank calls is presented in the Nordic Outlook - Unchartered territory, 4 April.

As a result, we see longer-term USD yields peaking ‘now’ and expect them to stay around current levels until autumn this year before starting to decline gradually, reflecting the expected easing cycle in 2024. The USD curve is currently heavily inverted due to markets expecting the Fed to start easing monetary policy as early as this summer. At the time of writing, markets are pricing three rate cuts of 25bp each between June and December this year. While we do not share this view, we do not expect a significant repricing posing considerable upside risk to longer-term USD yields, as markets are focusing on the next big move in rates markets, which is likely to be for lower rates. Historical evidence shows that, on average, the Fed has started cutting policy rates three quarters after the last rate hike. We currently expect a first rate cut from the Fed in Q1 24 followed by a sequence of cuts at a pace of one cut per quarter through 2024. This should likely support the lower rates narrative starting in autumn this year in anticipation of monetary policy easing.

As for the eurozone, we continue to see modest upside risk to longer-term yields on a 3M horizon in a curve flattening move, as the ECB is yet to show a strong hand in fighting the high underlying inflation prints, taking the front end up relative to the long end. We expect eurozone markets to start discussing and pricing 2024 rate cuts from the ECB towards the end of this year, trailing US markets slightly. This is likely to support longer-term yields on 6M-12M horizons. We project an ECB rate cutting cycle starting in summer 2024.

While the very high volatility in rates markets we observed one month ago has subsided somewhat, volatility has remained at elevated levels, and markets are currently pricing 10Y EUR swap rates in a broad 3.5 percentage point range by the end of our projected horizon (with a 90% probability).

Download The Full Yield Outlook

Author

Danske Research Team

Danske Bank A/S

Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.

AUD/USD hangs close to monthly lows, still defends 0.7100 ahead of Fed decision

AUD/USD retains its negative bias for the third straight day, defending 0.7100 while trading close to a monthly low in Wednesday's Asian session on Wednesday. The US Dollar stands firm near a two-week high as the anticipated Fed rate hike and oil-driven inflation fears continue to push US bond yields to a multi-year high. Furthermore, escalating Middle East tensions benefit the safe-haven buck and weigh on the risk-sensitive Aussie.

USD/JPY holds firm above 155.00, awaits Fed policy announcements

USD/JPY climbs to a fresh one-week high above 155.00 in the Asian session on Wednesday amid a bullish US Dollar. Oil-driven inflation fears, along with the anticipated Fed rate hike, continue to support surging US bond yields. Moreover, rising US-Iran tensions underpin the USD's reserve currency status. The pair, however, remains below the mid-155.00s as bulls seem hesitant ahead of the Fed decision later today and the BoJ meeting, starting on Thursday.

Gold defends key $4,280 support ahead of Fed verdict

Gold is attempting another run above $4,300 early Wednesday, replicating a tepid bounce seen in Tuesday’s Asian trading. Gold’s next major directional move depends on the US Federal Reserve monetary policy decision and outlook due later in the day.

Ethereum continues to attract capital despite impending rate hike and Clarity Act failure

Ethereum declined to $2,400 on Tuesday after the Clarity Act failed to progress in the Senate. Despite that and the market's near certainty of an interest rate hike at the next Federal Reserve (Fed) meeting, the top altcoin has continued to attract fresh capital. Ethereum buyers have been dominating sellers over the past few days.

August UK inflation report expected to show rising inflation

The United Kingdom Office for National Statistics will publish the highly anticipated Consumer Price Index data for August on Wednesday at 06:00 GMT. The inflation report could trigger volatility in the British Pound, as it comes just one day before the Bank of England monetary policy decision.

How Japan became the World's Banker and why that era may be ending

Japan's ultra-low interest rates helped finance trillions of dollars in global investments for more than a decade, making the Japanese Yen one of the world’s cheapest sources of funding. With the Bank of Japan expected to tighten policy again this week, that advantage may be entering a new phase. While most major economies raised interest rates, Japan remained the world's outlier.