A small move before the summer break

The ECB is preparing to cut its key interest rates, but the mood is hardly festive on the euro capital market. Persistent tensions have pushed the yield on the 10-year German Bund to around 2.65%, a level not seen since November 2023. The change in the shape of the euro yield curve reflects a reassessment of the trajectory of money market interest rates in the light of recent news.

While the rate cut expected on Thursday looks certain, given the myriad of signals coming from Christine Lagarde and her colleagues, hopes of a further cut in July are seriously undermined by persistent inflationary pressures. The acceleration in inflation from 2.4% in April to 2.6% in May was largely due to the rise in services prices, which were up 0.6% month-on-month and 4.1% year-on-year.

The ECB’s Governing Council is expected to reaffirm its willingness to be patient and to calibrate its policy based on future data. Investors will also be paying close attention to the updated growth and inflation forecasts for 2024 and 2025. The improvement in the business climate and an unemployment rate that fell to 6.4% in April, the lowest since the creation of the European Monetary Union, do not call for hasty action. The ECB could therefore move towards easing at quarterly intervals, bringing money market rates close to 3.25% by the end of the year.

Swiss franc bonds are also exhibiting rising yields. Thomas Jordan’s speech on equilibrium real interest rates (aka r*) mentions small inflation risks associated with a potentially overly accommodative monetary policy if r* is underestimated. This analysis suggests that we should not expect a substantial rate-cutting cycle, even though the SNB is probably preparing to cut its key rate again on 20 June.

On the US dollar capital market, the yield on the 10-year US T-Note rose above 4.6% before falling back below 4.5%. The moderate change in the personal consumption expenditure (PCE) price index in April (0.3% monthly, 2.7% year-on-year; 0.2% and 2.8% respectively excluding energy and food) is welcome, but needs to be confirmed over the next two to three months before the Federal Reserve will feel comfortable to cut its key interest rate.

Economic news in the USA is mixed. The rebound in the consumer confidence index in May, after three consecutive falls, does not call into question the moderation in demand that has begun to materialise. Without being alarming, the decline in the ISM index for the manufacturing sector (from 49.2 in April to 48.7 in May) suggests that monetary conditions are sufficiently restrictive to gradually restore price stability.