Fast reading
- Eurozone inflation rose to 2.6% in May – up from 2.4% in April – but remains well below the 10% level reach reached late 2022.
- The ECB is widely expected to cut rates by 25bps on 6 June, which has been all but fully priced in by rates markets.
- Should the ECB start its easing cycle before the US Federal Reserve, it raises questions about potential monetary policy divergence and the risk of exchange-rate volatility.
The European Central Bank (ECB) appears set to be the first major central bank to cut rates at its 6 June meeting next week. This could lead to a divergence from the US Federal Reserve given stronger-than-expected US economic data and the likelihood that the US central bank will maintain its current monetary policy stance.
Eurozone inflation rose to 2.6% in May – up from 2.4% in April – but remains well below the 10% level reach reached late 2022. The ECB benchmark deposit rate currently stands at 4%.
“The ECB is likely to begin its easing cycle next week, with a widely anticipated 25bps cut,” says Orla Garvey, Senior Portfolio Manager for Fixed Income at Federated Hermes Limited. “This is all but fully priced in by rates markets, but what comes after the next rate cut will be more difficult for the ECB to communicate and for markets to price.
“While significant progress has been made on bringing inflation back to target, the path of inflation from here is likely to be more turbulent. Combine this with an improving growth outlook across the eurozone, and markets may be less confident of the future path of ECB base rates, and lean towards pushing out some cuts in 2025 – as has been the case in recent weeks,” she adds.
Figure 1: Implied overnight rate and number of forecast ECB hikes/cuts
At the start of this year, the Fed was expected to lead the rate-cutting cycle, followed by other developed economies. Since then, however, investors have reined back their expectations on the number of anticipated cuts by the US central bank. The Bank of England, meanwhile, is widely expected to cut rates on 1 August. Should the ECB move first, it may raise questions about the scope and size of the potential monetary policy divergence and the risk of exchange-rate volatility.
Fed doubts hit US Treasuries
Figure 2: Two-year US Treasury yield snakes upwards
US equities, meanwhile, continued their recent slide. The Dow Jones Industrial Average closed down 0.9% on Thursday while the Nasdaq Composite was down 1.1%3. The only recent bright spot for investors was another set of blockbuster results from chipmaker Nvidia.
“This week saw the return of a narrow market as semi-conductors roared while the majority of the market languished in macro uncertainty,” says Louise Dudley, Portfolio Manager for Global Equities at Federated Hermes Limited.
There are still many questions regarding the widescale adoption and monetisation of artificial intelligence (AI)
“Though there are still many questions regarding the widescale adoption and monetisation of artificial intelligence (AI), the microchip space has been wildly successful. The hungry demand for high quality chips across mega caps and data centres suggests wider scale implementations of these models is on the horizon,” she says.
However, Dudley adds that “healthy dose of scepticism” is still required regarding the AI boom. “AI has been thrown around as a buzz word for a while now – but the path from implementation to profitability still needs to make sense,” she adds.
For further insights on fixed income, please see the latest Q2 2024 360° report.
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