Euro zone government bond yields saw an uptick in anticipation of the European Central Bank’s policy meeting on Thursday, following a reduction in expectations for interest-rate cuts early this year.
In a Reuters poll, 38 out of 85 economists (45%) suggested that the initial ECB cut might occur in June, while 21 and 23 respondents predicted April and the third quarter and beyond, respectively.
Money markets are now pricing in a minimal likelihood of a 25 basis points (bps) rate cut in March, with less than a 60% probability in April compared to a week ago when such a move was fully priced in.
Despite still discounting an almost 90% chance of a 50-bps reduction by June, taking into consideration the repricing for March and April, markets now assign a higher likelihood of the first move happening in June with a 50 bps cut.
Markets are now betting on rate cuts of around 135 bps by year-end, down from 145 bps a week ago.
Davide Oneglia, an economist at TS Lombard, attributes the reinforced “supply pessimism” among ECB hawks to “wage anxiety and risks of trade bottlenecks (due to the conflict in the Middle East).”
Market participants refer to central bank officials advocating a tight monetary policy to control inflation as hawks.
On Monday, U.S. and British forces conducted fresh strikes in Yemen, targeting a Houthi underground storage site.
The data calendar is relatively light on Tuesday, with anticipation for HCOB’s Composite Purchasing Managers’ Index (PMI), considered a reliable gauge of overall economic health, set to be released on Wednesday.
According to an ECB survey, Euro zone banks anticipate a modest rebound in demand for mortgages and loans to companies early this year, as the previous slump in lending shows early signs of moderating.
Germany’s 10-year government bond yield, the benchmark for the euro area, rose 1.5 bps to 2.30% after a 4.5 bps drop the previous day. It is approximately 20 bps higher than its level at the end of 2023, when markets increased bets on 2024 rate cuts by around 170 bps in low volumes, and 40 bps lower than in mid-November.
Germany’s 2-year bond yield, more responsive to expectations for policy rates, was down one bp at 2.68%, approximately 45 bps above its lowest level since March 2023, reached at the end of the previous year.
Rainer Guntermann, rate strategist at Commerzbank, anticipates the ECB to cut rates by 75 bps in 2024, starting from June, stating that “short-end valuations still look ambitious,” and the market may await new impetus from ECB President Christine Lagarde before the next leg lower.
Bond prices move inversely with yields.
Some analysts suggest that the rise in yields in 2024 aligns with investors closing short positions before the end of the year and establishing new ones in the first weeks of 2024.
Italy’s 10-year government bond yield increased by 3.5 bps to 3.87%, with the spread between Italian and German 10-year yields at 156 bps, up from its tightest level in 7 months at 151 bps the day before.
Peripheral bonds continue to attract solid demand from investors seeking to secure elevated yields that are expected to decline as soon as the ECB reduces rates.
