Traders Reprice Global Rates Path As ECB Meets To Discuss Cuts

Traders are betting the European Central Bank and Bank of England will deliver fewer and slower interest-rate cuts this year after a surprisingly hot inflation reading in the US spurred a rapid repricing in the outlook for monetary policy globally.

Money markets now anticipate just under three quarter-point rate cuts from the ECB this year, compared to earlier this week when there was a 50% chance of a fourth. In the case of the BOE, investors are pricing two interest-rate cuts this year, down from as many as three yesterday.

“It smells like a change in pricing paradigm,” said Benoit Gerard, a rates strategist at Natixis.

It’s an abrupt turnaround from the recent market narrative, which had increasingly seen all three major central banks delivering cuts in unison from the middle of the year. But with the US economy outperforming most of the developed world, that thesis is unraveling, setting markets up for an episode of higher volatility and a stronger dollar.

ECB to Hold With First Cut Locked In for June: Decision Guide

The moves come just hours ahead of the ECB’s decision. Economists expect interest rates to be held unchanged on Thursday but will be scrutinizing remarks by President Christine Lagarde. Data Wednesday showed US inflation topped forecasts for a third straight month, bolstering the case for a more cautious approach to easing. 

The ECB has previously indicated it will lower borrowing costs from June. While that’s still the base case for the market, it’s no longer fully priced. 

Bonds fell as traders reassessed the rates outlook. The yield on the two-year German note rose as much as four basis points to 3%, the highest since November. The euro, which had its worst daily drop in more than a year on Wednesday, consolidated. Gilts dropped, sending yields as much as 10 basis points higher across the curve.

Unlike the US, Europe’s economy has been flirting with a recession for more than a year, a divergence that has become all the more stark over the recent weeks. A recent survey of bank lending showed plunging corporate demand. Euro-area inflation undershot last month, slowing to 2.4% from 2.6% in February. 

“Lagarde’s reassurance of a first ECB rate cut in June should calm investors’ nerves,” said Commerzbank AG strategist Hauke Siemssen. In contrast to the US, economic data in the euro area “seems supportive of a cut”, he added.

Hawkish policy in the US could make it difficult for policymakers in the euro area to deliver multiple cuts. A significant divergence in interest rates could weigh heavily on the common currency, potentially sending it back toward parity with the dollar. 

The common currency was trading around $1.0736. MUFG’s Derek Halpenny sees the pair dropping toward $1.05 if Lagarde later indicates the central bank is on track to start cutting in June.

US Treasuries were slightly weaker in European trading, after posting their biggest selloff for months on Wednesday. Investors are signaling the Federal Reserve will cut interest rates just twice this year, starting in September.

“The Fed’s ability to cut rates anytime soon could be further questioned in the near term if official data remains robust – and more importantly – if US inflation dynamics refuse to point towards the Fed’s target again,” ING Group strategists including Padhraic Garvey. “Important for euro rates will be how the ECB is perceived as distancing itself from these dynamics.”

--With assistance from Naomi Tajitsu and James Hirai.

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