Upside risks to the long-end – Especially in the US
Over the past month, global swap rates have declined across the board. The Federal Government shutdown in the US, the re-escalation of the trade war between the US and China and weaker-than-expected economic data have cemented expectations of the next rate cut by the Federal Reserve (Fed) in October. The prospect of monetary easing has also pushed down long-end US rates, while concerns about debt levels continue to linger beneath the surface. The upward pressure on short-end Danish and European rates has eased recently, with 2-year EUR swap rates declining by around 5bp over the past month, supported by more dovish signals from the ECB. Similarly, the long end of the curve has also declined slightly, influenced by spillover effect from US rates.
Rate cut expected in October, but pace remains uncertain
Since 1 October, the US government has been hit by a significant shutdown, resulting in suspended activities and furloughed employees. The federal shutdown has also delayed the release of key economic data, including inflation and labour market figures. Combined with softer, albeit limited, data and the re-escalation of the trade war between the US and China, this has fuelled expectations that the Fed will deliver its next rate cut at the October meeting. Consequently, we have brought forward our Fed rate profile and now also expect the next rate cut in October. However, the pace and extent of rate cuts beyond this are more uncertain, as the US economy remains robust and inflationary pressures from expansionary fiscal policies and tariff hikes continue to loom. While we believe that the weakening of the labour market justifies monetary policy easing, we assess that markets underestimate the risk of inflation concerns resurfacing. Beyond October, we therefore anticipate three additional quarterly rate cuts of 0.25 percentage points through to late summer 2026, representing a more gradual monetary policy easing than the market currently anticipates.
Diverging opinions within the ECB
Recent economic data from the euro area have aligned with the ECB's expectations, pointing to modest growth driven by the services sector and inflation remaining close to the target. The Governing Council continues to state that the ECB is "in a good place", but there is growing divergence among members regarding the inflation outlook. This was evident in the minutes from the September meeting, where several members highlighted downside risks to inflation and expressed concerns regarding the euro's strength and households' persistently high savings rates. On the other hand, some members emphasised the potential inflationary effects of expansionary fiscal policies in the region and rising food inflation. We expect the key policy rate to remain at 2% until the end of 2026. The risk for short-end European rates remains tilted towards one final rate cut, although the threshold for such a move remains high. European wage data continues to indicate a considerable decline over the coming quarters, and the savings rate among European households remains elevated. This, despite our main forecast, could pave the way for a more dovish stance from the ECB later this year.
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.
