Yield outlook – Markets expect too many ECB hikes

Geopolitics remained at the forefront over the summer, and the war between the US and Iran continues with few signs of reconciliation. As a result, energy prices have gained renewed momentum, and the oil price has approached USD90 per barrel. The warm summer has also left its mark on the European gas market, where storage levels are at record lows. This has pushed the gas price above EUR60/MWh. Combined with a European economy that has proved surprisingly resilient, this has pushed European rates higher. The long end of the yield curve has also been lifted by renewed focus on the sustainability of public finances. Long-end government bond yields have risen to new highs, particularly in Japan and the US. On the other hand, short-end US rates have declined as a result of weaker macro data and a more hesitant Fed Chair.

Fed: Rate hikes still on the horizon despite weak data

Since our last Yield Outlook publication, US macro data has been on the weak side. In recent months, the labour market has increasingly shown signs of weakness, with weaker employment growth and declining wage pressure. In addition, inflation in both June and July was on the low side, reducing the immediate need for rate hikes in the US. At the latest meeting in July, three members voted for a rate hike, but there was still a clear majority in the committee in favour of keeping monetary policy rates unchanged. Among them was the relatively new Fed Chair Warsh, who was also far more neutral in his statement than at the previous meeting. We expect the Fed to deliver two rate hikes in December 2026 and March 2027, which would bring the key policy rate to 4.00-4.25%. We still see a risk that the rate hikes could come earlier, but the latest disappointing set of data leaves a more balanced risk picture.

ECB: A summer of positive growth surprises

In contrast to the US economy, the European economy surprised positively over the summer. Growth has generally been stronger than expected, with quarterly growth of 0.4% q/q in Q2, and several soft indicators point to an improvement in activity. ECB President Lagarde also highlighted this at the July meeting. She repeated that, so far, there were no signs of more persistent inflationary pressure, although there was some expectation of rising prices among companies across sectors and categories. We expect the ECB to deliver a final rate hike in September, but unlike the markets, which expect two additional rate hikes, we do not see the war triggering more persistent inflationary pressures. However, the lack of clarity in the Middle East and the latest series of positive surprises on the growth front postpone the immediate need for rate cuts next year. We continue to expect rate cuts in the first half of 2027, but increasingly see the possibility that the rate cuts will not be delivered until later in 2027.

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