Rates Spark: Growth disappointments on ECB day

The stagnating eurozone growth set a dovish backdrop for the European Central Bank meeting on Thursday. French, German and Italian GDP numbers for the last quarter of 2024 surprised to the downside and also the aggregate eurozone growth number disappointed with a 0% quarter-on-quarter reading. Such numbers pave the way for more easing and indeed the ECB cut the policy rate by another 25bp as was already widely anticipated.

Confidence in reaching the inflation target paired with the expressed notion that rates are still restrictive mean that the next cut is also pretty much consensus already. This would bring the policy rate to the top end of the estimated neutral range of 1.75% to 2.5%. President Christine Lagarde flagged an upcoming staff report on the neutral rate to be released on 7 February, which helped her defer the discussion to that moment. Come March and reaching 2.5%, further deferral is no longer an option.

Markets have added conviction to the view that the ECB might have to go further, with a 2% deposit facility rate by year-end becoming closer to being fully priced in. Overall the EUR curve bull steepened in reaction to the meeting and press conference. To us faltering growth numbers and an ECB showing a willingness to cut means that the front end of the euro swap curve can still move lower. And with the bearish sentiment in US rates markets fading for now, shorter-dated euro rates can find themselves lower again in the near term. But we also note that data remains a key driver.

US rates have traded with a slight bullish bias over the past week, with 10y Treasury yields probing their way towards 4.5%. With a view to the PCE data today and possible larger benchmark revisions to payrolls next week we are inclined to maintain that bias, but are equally aware that room for long end rates to go much lower is limited by where markets are seeing the Fed bottoming out. The SOFR futures strip sees its trough at 3.9% and the 10y SOFR OIS currently sits not far above at roughly 4.1%.

Complicating the picture is the news flow around US tariffs, with President Donald Trump reiterating his plans to impose 25% tariffs on Canada and Mexico starting February and also imposing fentanyl related tariffs on China. Even if announced over the weekend, it does not necessarily mean tariffs will be collected from day one. There could still be room for negotiation and excluding certain products. But the uncertainty could keep Fed expectations at more elevated levels and also constrain also longer rates.