Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Head of Fixed Income Strategy
Eurozone wage data has provided a boost to the euro, raising expectations for a hawkish shift in the ECB's rate outlook. Long-term Bunds have underperformed their peers, with 10-year Bund yields rising approximately 4 basis points to 2.22%, remaining within the narrow range established since the yen-unwinding selloff. Meanwhile, the U.S. dollar is under pressure, weighed down by dovish signals from the FOMC minutes and a downward revision in U.S. payrolls, which point to a softening jobs market.
Today’s Eurozone data paints a mixed picture: while consistent with a declining inflation outlook, it has not fully convinced markets that the ECB will be able to cut rates three times before the year’s end. Here’s why:
While markets are pricing in a rate cut for September, it’s crucial to remember that the ECB will soon release a new set of macroeconomic projections. These may include downward revisions to growth and upward revisions to inflation. Notably, in the second quarter, core inflation, according to the ECB’s June projections, was expected to drop to 2.7% but instead came in higher at 2.8%. At the same time, real GDP growth fell short of expectations, coming in at 0.3% instead of the projected 0.4%. Given the ECB’s primary mandate to control inflation, it’s unlikely they will revise inflation forecasts upward for the year and still proceed with a rate cut in September. A cut in October seems more plausible.
German bonds continue to be overpriced on the back of the release of negotiated pay data as they reflect an optimistic outlook that might not align with the economic reality.
German bonds saw significant gains in the recent quarter, with 2- and 10-year yields dropping nearly 50 basis points to 2.36% and 2.22% respectively from their peak in May. This suggests that investors have become increasingly confident that the European Central Bank (ECB) might ease its policy stance aggressively based on a weakening economic outlook. However, economic growth remains underpinned and strong wage growth indicates persistent inflationary pressures, particularly in services and core inflation, which the ECB is closely monitoring. Resilient in wage growth challenges the market's expectations of aggressive rate cuts.
Ten-year Bund yields remain confined within a narrow range established after the yen carry trade unwind. For yields to break out of this range, they would need to rise above 2.28% to signal an upward trend or fall below 2.17% to continue declining.
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