ECB Will Conduct a Third Consecutive (and 4th in total) 25 bps Rate Cut

Markets

November US CPI data came in bang in line with consensus. Monthly growth of 0.3% for both the headline and the core series resulted in annual readings of respectively 2.7% (from 2.6%) and 3.3% (stable). Contrarians betting on a status quo at next week’s FOMC meeting threw in the towel in absence of an upward surprise. The 25 bps rate cut is now fully discounted. The stalling disinflation process simultaneously strengthened the case for a Fed pause in January in anticipation of Trump’s inauguration and first official policy moves. The US yield curve initially bull steepened, but that morphed into a bear steepening pattern as tech and AI-stocks pushed Nasdaq to closing gains of 1.77%. The US $39bn 10-yr Note auction met with stellar demand, but couldn’t prevent more selling pressure into the bell. Daily changes on the US yield curve ranged between +0.9 bps (2-yr) and +6.3 bps (30-yr). We recently stressed the nascent bottoming out process at the (very) long end on (global) yield curves and find more evidence in Europe as well. German yield changes varied between -1.1 bp (2-yr) and +2.3 bps (30-yr) yesterday. The single currency abides to the rules of gravity going into today’s ECB decision with EUR/USD changing hands around 1.05 and EUR/GBP closing in on the post-brexit low of 0.8203.

The ECB will conduct a third consecutive (and 4th in total) 25 bps rate cut. A lower GDP and CPI outlook will be covered by uncertainty (and downside risks). It will prompt a different tone in the policy statement, erasing the expressed need to keep policy restrictive for as long as necessary to bring inflation sustainably back to 2%. Returning to forward looking decision making instead of data dependence allows the ECB early next year to ignore any possible hick-ups in a still bumpy inflation path, instead arguing that price stability will be achieved in the longer run. We expect those dovish twists to hold end of 2025 money market rates below neutral levels (+- 2.25%) even if we don’t think that this will eventually materialize. Apart from the most dovish governors, no ECB official suggested moving back below neutral. As (hawkish) ECB Schnabel pointed out, a stimulative monetary policy can help overcome cyclical economic weakness but doesn’t fix the structural issues Europe is struggling with. More curve steepening and a lower euro are today’s likely way forward.

News & Views

Brazil went big yesterday by raising the policy rate a more-than-anticipated 100 bps to 12.25%. The central bank (BCB) went even further and clearly indicated similar hikes over the next two meetings if the scenario unfolds as expected. The domestic economy keeps on booming and (underlying) inflation has increased further above the 3% (+/- 1.5ppt) target. Inflation expectations rose significantly to hover around 4.8% and 4.6% for this year and 2025 respectively. The central bank notes that the upside inflation risks mentioned last time have now materialized, turning the inflation scenario more adverse. Risks remain tilted to the upside and include a more prolonged period of deanchoring inflation expectations, a stronger economy and currency depreciation. The Brazilian real slid against USD with the latest downleg spanning from USD/BRL 5.4 mid-September to a record low around 6, fanning the inflation fire. The real has yet to react to yesterday’s monetary policy decision. The Brazilian central bank does not take a formal stand on the fiscal policy developments, including some spending cuts announced end of November, but concluded that market’s perceptions of it have only contributed to more adverse inflation dynamics.

Australian employment rose 35.6k in November, more than the 15.9k in October and above the 25k consensus estimate. Full time employment carried the headline figure by adding 52.6k jobs. The unemployment rate unexpectedly fell to 3.9%. The participation rate ease to 67%, be it from a historical high 67.1% in October. The Bureau of Statistics said that “Compared with outcomes before the COVID-19 pandemic, the unemployment and underemployment measures are still low, while trend employment and participation measures are around all-time highs. This suggests the labour market continues to be relatively tight.” The strong labour market report follows a dovish RBA-twist earlier this week. The RBA brought life in the December rate cut expectations. Such a move was priced in for two-thirds up until this morning. A first full rate cut is now only seen in April next year. Australian swap rates soar 11 bps at the front end of the curve. AUD/USD rebounds from recent lows sub 0.64 to 0.642.