ECB Cheat Sheet: Start and stop

In rates markets, a cut by the European Central Bank on Thursday is already fully baked into the curve, with forward pricing nearly 25bp. But it's the outlook beyond June that is still open, despite communication from officials having started to move out the curve. A back-to-back cut in July is deemed unlikely, with markets attaching only a roughly 10% chance to that scenario. A second cut is almost fully priced by October, but it’s a third cut this year that is hanging in the balance.

However, the pricing further out the curve is also influenced by drivers from abroad. Weaker US data as well as sliding oil prices have also helped push rates lower in the eurozone. While EUR markets have been leaning towards a three-cut scenario for this year again, the domestic data on negotiated wages and the latest CPI print over the past weeks would argue for a more hawkish line at the upcoming meeting.

Therefore, there is room for markets to reprice higher – but in the end, we believe that they will still oscillate around the two or three-cuts scenario for now unless we get more evidence from the data. This will also spill out into the longer end of the curve, but here the factors from abroad should be felt even more with the US jobs data looming large. This will then determine whether we can get above 2.6% more lastingly in the 10Y Bund yield on a hawkish ECB.

The ECB's forward guidance experience (i.e., signalling a June rate cut) may be short-lived. As outlined in our baseline scenario, we expect the ECB to scale back its guidance endeavour and swing back towards data dependency after stronger-than-expected wages and inflation figures.

EUR/USD has been trapped in a relatively tight range, and still relies more on cues from US macro than eurozone developments for the next big move. If some lack of guidance by the ECB can be read as a hawkish signal and give some support to the euro short term, the fact that the ECB has moved before the Federal Reserve – and despite higher inflation and wages – should make markets quite comfortable with jumping back into pricing in two more cuts in 2024 (after the June move).

Markets have been more reticent to price in easing in the US of late – but if we are right with our call for a first Fed cut in September, then the dollar should have a bad summer. While the euro (along with CAD and GBP) may lag other pro-cyclical G10 currencies in a USD decline, EUR/USD should still be able to make it to 1.10 in the coming months.