Rates Spark: Steadier, but big moves coming

Markets are pricing in a possibility of consecutive European Central Bank cuts after September, but should also be careful not to get ahead of themselves. German and Spanish CPIs tomorrow will prepare markets for the eurozone figures on Friday. An element of stability has broken out over the past few weeks in terms of the level of rates, although the 2/10yr spread has managed to stretch steeper (dis-inversion) on front end comfort with the Fed prognosis.

We sent out a note earlier on the direction of travel for longer rates against a reference where the Fed delivers on the current market discount for the funds rate. It's here. Essentially we are saying that the 10yr SOFR rate, now at 3.4%, is already overshooting to the downside. It can get as low as 3% as the rate cutting gets going. But there is little relative value sense to it breaking below 3%, as the Fed itself is not discounted to break below 3%.

If or when the 10yr gets to that type of level, we expect it to spark a journey back up to 4%. That journey should begin around the turn of the year, at the very latest.

Little notable data coming in for the eurozone, but this was more than compensated with a heavy supply pipeline, including syndications from the EIB and Austria. Markets seemed to digest the issuance well, with yields ending the day lower across the curve.

Tomorrow Germany and Spain will publish CPI numbers for August, which will warm up markets for the eurozone figures on Friday. Headline figures are expected to come down to a consensus 2.2% for Germany and 2.5% for Spain, thereby looking good at face value. But in the end it will be the eurozone’s core inflation that will decide about the ECB’s room to cut and that number has resisted coming down.

As long as the eurozone’s jobs market remains resilient and consequential wage growth strong, markets should be careful about extrapolating a cut in September to consecutive meetings. The front end of the curve can still go lower, but euro markets may need to be more patient than their USD counterparts. Having said that, a further steepening of the UST curve on the back of Fed cuts will pass through to the Bund curve.