The European Central Bank meeting next week is the one that markets will watch after the Fed held rates steady on Wednesday. But while the consensus is that nothing will happen, the ‘good place’ the ECB sees itself in is looking less comfortable, as our economists note. For now, the underlying story might still look good for the eurozone. But exchange rate dynamics put downward pressure on inflation projections, while at the same time, cold weather and tensions around Iran have pressured energy prices higher. To compound market worries, AI concerns are resurfacing of late, sending US tech stocks lower and the rest with it.
Markets are increasingly starting to question again whether the ECB will be able to hold a steady course amid increasing cross currents. The implied probability of the ECB cutting rates before the year is out has crept over 30%.
Shorter dated inflation swaps are actually still up by more than 10bp since the start of the year, while real rates are sliding further from the peaks we saw then – the 5y real ESTR OIS rate is down from 0.55% to 0.35% just this month. Admittedly, setting aside December, that is still the upper end of the range since last April.
Even as 10y US Treasury yields are staying largely pat, 10y Bunds yields are falling closer to 2.8% and sagging risk appetite is also reflected in a rewidening of spreads in the eurozone bond market, where French bonds are underperforming as the 10y spread over Bunds climbs closer to 60bp again.