By Mike Dolan
LONDON (Reuters) – June’s central banking gathering is being erased from the diaries as markets now suspect the Federal Reserve will dig back its heels on a first interest rate cut by then and let the European Central Bank proceed from alone.
And the persistent stability of the transatlantic exchange rate, despite this shift in political thinking, could give the ECB the courage to carry on regardless, with the euro/dollar still stuck in the middle of an 18-month 8-cent range .
One of the most notable aspects of the global rates market during the first quarter was pricing on both the timing and extent of credit easing by the Fed and ECB this year, despite vastly different underlying economic conditions.
While the last year’s impressive disinflation in both the US and the eurozone has given both central banks the amber light to start reducing the highest borrowing costs in two decades, the near-recession in the eurozone contrasts with the still brisk expansion of the US and a super tight job market there.
The combination of yet another US payroll boom last month and persistent inflation data in the new year has seen many Fed officials dampen market hopes for a cut as early as June – with some even suggesting that any cut rates this year could soon be off the agenda without further significant changes. improvement in inflation. Wednesday’s consumer price update could reinforce this view.
But as the ECB meets this Thursday, all the stars are still aligned to signal easing by mid-year – with core inflation continuing to fall last month and a bleak reading on bank lending for the first quarter that shows restrictive credit conditions getting tough.
“We will know more in April, but we will know much more in June,” ECB chief Christine Lagarde said after the last meeting just over a month ago.
‘PLUSIBILITY RANGE’
Gilles Moec, chief economist at AXA Group, believes staggered rate movements are now a real possibility and that the relatively relaxed euro could be key to encouraging such a trend.
“That the ECB cuts before the Fed is absolutely within our ‘scope of plausibility,’” he wrote. “The euro exchange rate has just weakened despite a reversal of market expectations on monetary policy rate differentials (and) this should encourage the ECB to make the right decisions for the euro area, regardless of what the Fed will do in the end.”
Moec argues that the only channel through which the Fed’s hesitation could impact the ECB’s solitary action in June is through the exchange rate – where a surge in the dollar could see renewed pressure on dollar imports and on raw material prices for the block.
The fact that the euro/dollar rate has barely moved in the last month puts everything aside.
Earlier this month, futures markets had fully priced in a quarter-point rate cut by the Fed in June, but the probability has since been reduced to 50-50. The ECB remains fully priced in for a June move.
S&P Global Market Intelligence’s Chris Williamson believes talk of an earlier ECB move is justified by underlying momentum in both eurozone consumer price trends and price readings from regional purchasing manager surveys.
“CPI and PMI data… suggest the ECB will be the first to see inflation reach – and stay below – target, with the US lagging behind in the inflation battle.”
SHUFFLING THE DECK
To be honest, juggling the dates of a first move can seem a bit academic. After all, even though money market traders feared June, they still see a full quarter point of easing by the end of July.
But it is the changes in the size of the future easing cycle that are perhaps most significant. Currently only 63 basis points of cuts by the Fed are expected for the rest of the year, but 85 basis points of cuts by the ECB are still set.
Pushing it further, the Fed’s so-called “terminal rate,” captured by money market futures, has risen again to near 4.0% for the start of 2027 – nearly a full percentage point higher than at the start of the year and implying the entire easing cycle could be as little as 150 basis points in total.
The ECB equivalent already predicts 175 basis points by the end of next year.
Further afield, the outperformance of the eurozone government bond market has seen the transatlantic five-year yield gap widen by more than a quarter of a point since the start of last month, giving the US a nominal yield premium of over 200 basis points for the first time this year. year.
Indeed, the five-year yield premium has now more than doubled in just 12 months and the euro/dollar exchange rate is exactly where it was on April 10, 2023.
Green light for the ECB?
The opinions expressed here are those of the author, a Reuters columnist.