Overnight index swaps (OIS) are pricing in a near 100% chance of a 25-basis point rate cut from the European Central Bank (ECB) at their June 6th meeting. Given the base effect setup for economic activity and upward direction in market data out of Europe, we will be noting how council members of the ECB talk about the decision to cut its policy rate, should they do as the market expects. Ultimately, we believe the current environment is not conducive to reoccurring policy easing, which may impact other central banks and the Fed’s decision making.
Looking at the OIS data, the market currently expects a 25-basis point rate cut in June, followed by a pause in July, then an additional 25-basis point rate cut to occur by year end. This would bring the target rate from 4.00% to 3.50%, still well above the 0% rate the ECB held from 2016 through the start of the current hiking cycle.
Source: Bloomberg.
Source: Macrobond.
The base effect setup for growth and inflation ease meaningfully during the period within which the ECB is expected to be cutting its policy rate. This is important because central banks typically do not pivot to a dovish stance when economic activity is improving.
Source: Macrobond.
Additionally, interest rates have been moving higher across the curve in major EU countries like Germany, Italy, and Spain. The 10-year yield in Germany has increased by more than 60 basis points since the end of last year and is roughly in line with where it was in November 2023, just as the market began heavily discounting rate cuts starting as early as March 2024. Italian and Spanish 10-year yields have followed a similar path, both up by more than 40 basis points since the end of last year.
Source: Macrobond.
At the same time, equity ETF performance in many EU countries has been improving and many of the local stock indexes are at or near all-time highs. Over the last three months, all European equity ETFs have been outperforming the SPDR ACWI Ex-US ETF (ACWX), and only France (EWQ) lags the SPDR S&P 500 ETF (SPY).
Source: Macrobond.
Given the increasing probability that growth and inflation accelerate in the second half of 2024, rising government bond yields, and improving equity performance, it is an unusual environment for the ECB to cut rates, especially beyond what is currently priced in. We will continue to monitor incoming economic and market trends following the ECB meeting tomorrow and leading into the Fed meeting next week.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Investment Strategist
Boyd Watterson Asset Management, LLC