Rates Spark: No desire to micro manage

US Treasuries saw a decent bear flattening over yesterday’s session as front-end rates moved around 10bp higher. Last Friday, the rate cut discount for the Federal Reserve had deepened to a substantial 135bp of easing over the course of 2024. This has now come off a bit.

The Fed is now in its pre-meeting blackout period, so the next cues will have to come from the data. The key piece of information will be Friday’s jobs report. The expectations of very early cuts – such as the 50% probability attached to the March meeting – look like a stretch to us, and the jobs data is unlikely to provide that validation if the consensus is right about the 186k figure, up from last month’s very soft 150k. But the market does appear more sensitive to downside surprises.

Unlike the Fed, the European Central Bank (ECB) still has a good part of this week to steer expectations before next week’s meeting. But it does not appear that there is a great urge on the side of the ECB to “correct” market pricing despite its apparent clash with the official high-for-longer line. The ECB’s Vice President, Luis de Guindos, acknowledged that the recent inflation reports were a positive surprise but also said it was too early to declare victory. Calling for caution, he pointed to still large wage increases in parts of the eurozone. This morning, Isabel Schnabel also confirmed in a Reuters interview that further rate hikes could be taken off the table given the "remarkable" fall in inflation, but also warned about guiding markets on rates moves too far ahead given the rapid changes in inflation.

The ECB is looking at markets discounting a more than 50% chance for a March rate cut and overall 135bp of easing over the next year. But at the same time, the market rally that got us there was in good part driven by declining inflation expectations – the right kind of driver in the eyes of the ECB, if only a bit too exuberant. It also means that looking at real interest rates as a gauge for the effective policy stance, we are still above the average since July and only marginally below average in medium to longer tenors.

The ECB probably also has little desire to micro manage and add to market volatility as markets already seem to gear down into year-end. In longer rates, for instance, government bond supply is slowing with final auctions seen by Germany, France and Spain this week, which may well support the lower yields. And to the degree that pricing is inspired from US dynamics there is a lot that can change with key data this week.