Rates Spark: Shifting the timing, not the landing

Rates are still looking to go higher. Despite a stronger start into yesterday's session, bearish sentiment prevailed by the end of the day with eurozone bond markets also having to digest sizeable long-end supply, foremost a new 30Y French benchmark – this time the curve resteepened from the long end.

Yet, the overall driver remains the macro backdrop and with it, the assessment of policy paths, foremost of the Federal Reserve. The market is still sensitive to the data as witnessed by yesterday's reaction to the durable goods orders, or more precisely the stronger capital goods shipments which enter GDP calculations. But the market also appears somewhat selective. A notable decline in the Conference Board's consumer confidence left rates unfazed. But we have reached one bearish milestone. With the repricing of the front end, the market is now aligned with the Fed's median dot plot showing three 25bp cuts this year.

Euro rates have joined the pushback of rate cuts in US markets, but the landing zone has remained relatively unchanged. Forward curves now price in 100bp of rate cuts in 2024, compared to almost 150bp a month ago. At the same time, 1y1y forwards joined the trend upwards, indicating that in 2025, the policy rate is also expected to remain higher (see chart below). But when looking ahead at 2026 and beyond – as captured by the 2y1y and 3y1y forwards – we note that those points remain relatively anchored. This divergence suggests that recent rate moves were driven predominantly by a change in the timing of cuts and less so by a conviction that the end point is higher.

The picture is similar, though not quite as pronounced, in the US as the market did tilt more towards a soft landing scenario, and the data surprises to the upside appear to corroborate this view. But at some point, with higher rates for longer, the risk of a hard landing further down the line should increase. The overall economy has so far shown resilience despite a tightening of monetary policy, but in the end, only one pillar needs to break to drag the rest down. An obvious candidate in the US is the commercial real estate sector, but also steep delinquencies and rising credit card rates cannot be ignored. As long as policy rates remain restrictive, the buildup in such pockets of risk will keep increasing.

For now, the market has put hard landing risks on the back burner in Europe and obviously, the US, which has also prevented a deeper inversion of curves. Despite potentially higher hard landing risks in the future, we expect markets to maintain a bearish bias towards bonds in the immediate near term.