As expected, the ECB and the Bank of England left their key interest rates unchanged at 4% and 5.25% respectively yesterday. Unlike the Fed, they didn’t confirm any aggressive rate cut bets. In its new staff projections, the ECB lowered its inflation path for this year (5.4% from 5.6%) and next year (2.7% from 3.2%), but it will still take some time to bring inflation back to the 2% target (2.1% in 2025; 1.9% in 2026). At the press conference, ECB Chair Lagarde warned that it’s absolutely not the time to lower the inflation guard. Among other things, the central bank remains concerned about the inflationary impact of future wage increases. In this context, there is no reason to talk about rate cuts yet.
The ECB also decided to start reducing the PEPP portfolio by EUR 7.5 bn/month in H2. It will stop reinvesting at the end of 2024. European yields hit intraday lows during the morning session after the Fed’s dovish turn on Wednesday, but gradually regained some ground after the ECB decision and press conference. German yields were still down between 10 bps (2y) and 1.9 bps (30y). US yields continued to fall as the Fed openly prepares for rate cuts in 2024. Notably, longer-dated bonds outperformed. US yields fell between 3.8 bps (2y) and 14 bps (30y).
US November retail sales (control group +0.4% m/m) and weekly jobless claims (down to a low 202k) suggested continued economic resilience. Understandably, the data had limited impact. The prospect of Fed easing next year continued to support equities, with several US and European indices nearing or touching post-Corona highs. The ‘policy divergence’ between the Fed and the likes of the ECB and BoE kept the dollar on the defensive.
EUR/USD tested the 1.10 area, but hasn’t yet broken the 1.1017 top from late November. In the BoE decision, 3 members of the 9-member MPC voted for another hike and the BoE reaffirmed the need to remain restrictive and to extend the period. Gilts underperformed (2y -1.9 bps). The Pound gained against the Dollar. EUR/GBP whipsawed around the 0.86 major level (close 0.8611).
Today, the market will focus on the preliminary PMI’s for December. The US Composite PMI is expected to decline slightly from 50.7 to 50.5. The EMU measure is expected to improve slightly from 47.6 to 48, but both manufacturing (44.6) and services (49) are expected to remain in contraction territory. After the recent sharp drop in yields, the market dynamics may gradually change a bit. Outright weak data could confirm the downtrend in yields. However, data in line with or better than expected could slow the market’s push for early rate cuts. In the currency markets, the dollar is fighting an uphill battle. A EUR/USD break above the late November high of 1.1017 puts the YTD high of 1.1276 on the radar.
