Here we are: tomorrow, Thursday 11 April, is ECB Day, the day on which the European Central Bank led by Christine Lagarde will announce its decision on rates, commenting on the trend in GDP growth and inflation in the euro area, thus waiting hopefully, to make the big monetary policy move at the June meeting.
While waiting for the Eurotower’s historic monetary policy turning point, excellent news arrives for BTPs – therefore consequently for the BTP-Bund spread – and for government bonds, or even government bonds, of the entire euro area.
In recent weeks, the large managers of Pimco, JPMorgan Asset Management and T Rowe Price have all increased their exposure to the sovereign debts of Eurozone countries, betting on a rate cut by the ECB which will arrive before that of the Fed. This is what an article in the Financial Times reports, focusing on the other spread that is worth monitoring: the US-Germany spread, or 10-year Treasury-Bund: this is the differential between the rates of US government bonds and those Germans
Another Reuters article also identifies euro area bonds as the winning assets of the rate cuts that Lagarde’s ECB, not tomorrow, but in June, will be forced to announce against its will, in spite of the perennial anxiety towards inflation, which continues to remain above the target set by Frankfurt, equal to 2%.
Of course, those who trade BTP & Co. will have to wait another two months or so before starting to rub their hands: but a cut in euro area rates in June seems like a die has already been cast, in the wake of the numbers relating to inflation in the block.
In this situation, according to the consensus of economists, tomorrow the rates on main refinancing operations, marginal refinancing operations and deposits at the central bank will be left unchanged al 4.50%, al 4.75% and al 4.00%after the last monetary tightening which dates back to the September 2023 meeting.
“FirstFT: Traders buy European over US bonds in bet on swifter ECB rate cuts”: is the title of the Financial Times (FT) article, namely: “Traders are buying more European bonds than US ones, betting on faster rate cuts by the ECB”.
“The path of rate cuts in Europe is clearer than that of the United States – commented Bob Michele, head of the investment division and global head of the fixed income division of JPMorgan Asset Management to the City newspaper – It is it is difficult to identify an economic reason that supports (instead) the Fed cutting rates”.
It’s not just the managers and strategists who are speaking: the markets themselves are having their say, pricing in a divergence between US rates and those of the euro area.
Mohamed El-Erian himself, Bloomberg Opinion columnist, director of Queen’s College in Cambridge and former CEO of Pimco, spoke about this divergence, stating in an interview given yesterday to Bloomberg Television that the slowdown in Eurozone GDP growth and the more convincing disinflationary process taking place in the bloc could lead the ECB to cut interest rates even more than the Fed:
“something that until a few months ago was something unimaginable” and something that “is having a huge impact” on the way financial markets are pricing in the next rate moves in Europe and the United States.
“You can see it in the bond markets, and you can see it in the currency market”, or in forex where there is, in his opinion, “the possibility” of seeing the euro capitulates to the point of reaching parity against the dollar.
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With its analysis ECB’s rate cuts can help bond traders – and itself the Reuters agency also sees a bright future for government debts in the euro area, recalling that “in lowering rates in June, before other central banks, the President of the ECB could help those investors in euro area government bonds who have been suffering for a long time, and the ECB itself.”
In quoting Wall Street’s saying, “Bonds may be smarter than equities”, Reuters recalled that so far the trading of European government debt in recent years has not reflected the meaning of this adage. In fact, the index that measures the performance of the bloc’s government bonds compiled by S&P Global has lost 13.6% over the last three years, compared to the +16% recorded by the STOXX Europe 600 Index (.STOXX) , i.e. the benchmark index that measures the trend of European stocks.
The reference is to the S&P Eurozone Sovereign Bond Index, an index of Eurozone sovereign bonds. With its tireless fight against euro area inflation, the ECB has effectively unleashed a strong growth in euro area bond rates, ballasting prices. The result is that the bond market has suffered heavy losses over the last three years, with the reference index drawn up by the rating agency S&P relating to sovereign bonds in the entire euro area fell by 12.8%.
In the same period of time, i.e. in the last three years, not even the index drawn up by S&P which monitors the trend of BTPs, i.e. lo S&P Italy Sovereign Bond Index, scivolato del 9%.
It is worth highlighting that the rally that BTPs reported during 2023 caused the same index to rise by 8% last year. Below, the performance graph of the S&P Italy Sovereign Bond Index of the last three years.
Now, however, with the bloc’s inflation finally falling, the ECB – after the Swiss National Bank, or Central Bank of Switzerland, could be the first major central bank to cut rates, before the United States Federal Reserve led by by Jerome Powell and also by the Bank of England.
“Markets believe there is a greater than 90% chance that the ECB will cut rates in June, compared to a 50% chance that the other two (the Fed and the Bank of England) will do the same, based on prices on derivatives compiled by LSEG,” reads the Reuters article.
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Meanwhile, on what will happen tomorrow during ECB Day, here are the comments of some experts:
François Rimeu, Senior Strategist at La Française AMsays that the ECB is expected to confirm the status quo on rates tomorrow, but also that ECB President Christine Lagarde is likely to announce that the Governing Council will lower interest rates in June, while proceeding with easing with caution, especially given the better macroeconomic prospects”.
La Française AM recalls that “Lagarde has announced that the ECB will cut interest rates in June, probably by 25 basis points, given greater confidence in achieving the 2% inflation target”, reiterating that “monetary decisions will continue to depend on the data and that we will proceed with a ‘meeting by meeting’ approach”, an attitude that leads us to believe that there will still be “no indications on how the ECB will cut interest rates after the first move”.
The strategist is therefore of the opinion that the Governing Council “will probably proceed with caution and that the pace of easing will depend exclusively on the data. As a result, this meeting is expected to have a limited impact on financial markets, but will likely push European interest rates and the euro lower, given that the first cut will come after a series of unprecedented interest rate hikes, for a total of 450 basis points”.
Filippo Diodovich, Senior Market Strategist of IG Italia, expressed his view on the ECB’s next moves, including the one scheduled for tomorrow, in the note: “Preview ECB: rates unchanged, probable commitment to a rate cut in June , few details for the second semester”.
“Tomorrow the Governing Council of the European Central Bank will meet in Frankfurt to decide on monetary policy. At 2.15 pm Italian time the ECB will communicate its choices on interest rates and at 2.45 pm the governor of the central bank, Christine Lagarde, will hold the press conference on the decisions”.
Diodovich took stock of the expectations for the outcome of the meeting:
Interest rates unchanged at current levels (deposit rate at 4%, interest rate on main refinancing operations at 4.50%, interest rate on marginal refinancing operations at 4.75%). Indications on a possible cut in the cost of money in June, but few details on the next monetary policy moves in the second half of the year (waiting for the ECB experts’ estimates on inflation, unemployment and GDP which will be published at the next meeting in June). Maintaining a ‘data-dependent’ attitude, i.e. linked to the performance of macroeconomic variables.
Senior Market Strategist of IG Italia then underlined that, “taking into account the weak state of health of the main Eurozone economies and the disinflation process, we believe that the governor of the ECB Christine Lagarde can give important indications on a possible cut in the cost of money in June, confirming market expectations.”
However, there was no shortage of attention: “We believe, however, that Lagarde can stop here by not providing further details on the monetary strategies after the June meeting. The decisions will depend on the next estimates of the central bank experts on inflation and GDP which will be published at the June meeting”.
“European central bankers are particularly cautious for two reasons – explained Diodovich – Inflation in the services sector remains particularly high (4% on an annual basis); the uncertainty that surrounds the monetary policy of the Federal Reserve, which is close but not too close to cutting interest rates too”.
Having said this, “the markets are pricing in the ECB’s cut in June with probabilities well above 95%”.
“A reduction in the cost of money in tomorrow’s meeting would be” according to IG’s senior strategist “a very surprising move that would lead to a sharp decline in the prices of the euro compared to other international currencies”.
In general, “the greatest interest for the financial community will be to evaluate Christine Lagarde’s statements to understand what path in monetary policy the Frankfurt institute will want to follow in the second part of the year. At the moment the markets are discounting a total of 90/100 basis points of cuts (i.e. a deposit rate of 3% at the end of the year)”.
IG Italia’s expectations, concluded Filippo Diodovich, are less dovish than the market. We expect, in addition to the June cut, which we consider almost certain, two more cuts to be made in the next four meetings (July, September, October and December), thus bringing the deposit rate at the end of the year to 3.25%”.