Global Daily – What is priced in for the ECB and Fed

by: Nick Kounis , Bill Diviney

Euro Rates: ECB expected to hike in October next year – ECB rate hike expectations were scaled back following the June Governing Council meeting, when the central bank made its forward guidance more concrete, saying interest rates would remain on hold at least through the summer of next year. Over recent weeks they have re-traced somewhat. According to EONIA swaps and Euribor futures, we estimate that there is a significant probability of 10bp rate hike priced in for September of next year, with one fully priced in for October. The consensus of economists (according to Bloomberg) is more hawkish, with a 20bp hike expected by September of next year. We expect the ECB to raise its deposit rate only in December of next year (by 10bp to -0.3), reflecting the likelihood that core inflation will undershoot the central bank’s forecasts. This implies another round of ECB re-pricing. Given that no rate hikes are priced in any case for the coming year, we do not expect to see a big impact on the short end from any ECB repricing. Rather, we would expect to see lower German 5y and 10y yields over the next three months. That means we should see 2s5s and 2s10s flattening over the next few months, while 10s30s should steepen. The various risks that continue to linger (such as a further escalation of Italian credit risk or protectionist measures) could also contribute to flattening pressure. (Nick Kounis)

US Rates: September hike nearly fully priced, but less conviction further out – The 10y Treasury yield broke out to the highest level in more than a month today at 2.95%. Although the trigger appears to have been the overnight jump in JGB yields, it likely also reflects a more sanguine view of the macro implications of trade policy uncertainty. Indeed, while the risks around the President’s policies are as high as they have ever been, business confidence has held up remarkably well so far. Although we see an elevated risk that trade policy dampens confidence and in turn investment, our base case remains that the macro implications will be limited, and that the Fed will continue hiking at a quarterly pace until next June. The market seems to be coming around to this view – a September hike is now almost fully (92%) priced by OIS forwards, up from c.80% earlier in the month. Further out, the conviction level in additional rate hikes becomes weaker, however; pricing for a December hike is at 68%, next March at 56%, and next June at 52%. All told, 66bp of the 100bp in tightening we project to next June is now priced in. Although there is clearly scope for the market to price in rate hikes with greater conviction at some point, expectations will likely remain subdued until uncertainty over trade policy recedes. (Bill Diviney)