EMU Money Markets Currently Attach Near 50% Probability to ECB Scaling Rate Cuts Up to 50 bps in December

Markets

German Bunds significantly outperformed US Treasuries yesterday, especially at the front end of the curve. The German 2-yr yield lost 7.2 bps compared with a 4.7 bps increase for the US 2-yr yield. EUR/USD as a result tested 1.0778 support a first time (close: 1.0782). ECB governors kept all options open for the December policy meeting in comments on the sidelines of the IMF’s World Economic Outlook in Washington. In brief: downside growth risks could accelerate an already faster-than-expected disinflation process and eventually result in an undershoot of the 2% inflation target. ECB Lagarde underlined that the direction of travel is clear and that the pace will be determined on the basis of backward- and forward-looking elements using the three criteria (inflation outlook, dynamics of underlying inflation and the strength of monetary transmission) and applying judgment. EMU money markets currently attach a near 50% probability to the ECB scaling rate cuts up to 50 bps in December. October PMI surveys are the first piece of the data puzzle today. Over the past months, we’ve seen a divergence between very weak EMU sentiment data and more modest (but often ignored and labelled outdated) hard data. Next week’s Q3 EMU GDP numbers can therefore deliver a (much) better outcome than the 0.0% GDP growth as suggested by the PMI-based model. Consensus doesn’t expect much improvement in today’s (October) PMI’s compared to upwardly revised (but also ignored) September figures. They could be the straw to brake EUR/USD’s back. EUR/GBP yesterday bounced off 0.83-support in the run-up to BoE Bailey’s speech in Washington. He stressed that disinflation is happening faster than expected though services inflation remains higher than is consistent with target. This suggests that he’ll still push for a 25 bps rate cut at the November BoE meeting. UK & US PMI’s and US weekly jobless claims are up for release as well today, offering an interesting and likely volatile mix in an era of extremely data-dependence. Genuine dollar strength and rising US rates propelled USD/JPY from 140 mid-September to 153 yesterday, prompting a first verbal intervention by Japanese Finance Minister Kato against one-sided rapid moves in FX markets.

News & Views

The Bank of Canada upped the pace in its easing cycle yesterday and lowered the policy rate by 50 bps to 3.75%. This came after inflation eased sharply from 2.7% to 1.6%. Aside from declining oil prices, the BoC sees notoriously sticky shelter costs have begun to ease. Excess supply elsewhere in the economy has reduced inflation in the prices of many other goods and services, it said, adding that its preferred measures of core inflation are now below 2.5%. With inflation now back around the 2% mid-point target and a lacklustre economy, the central bank put governor Macklem’s words in September – when he offered the possibility of easing faster – to practice. Canadian GDP is expected to strengthen gradually over 2024-2025-2026 (1.2%-2.1%-2.3%) amid lower rates supporting consumption, residential & business investment. Exports should benefit from robust demand from the US. Inflation saw some small downward revisions in the first two years of the policy horizon to be at 2.5%-2.2%-2.0%. The BoC commits to further cuts if the economy evolves as expected but the timing and pace is guided by incoming data. With yesterday’s move largely priced in the Canadian dollar only lost limited ground to USD/CAD 1.3836. The Loonie had been dropping significantly in the run-up since end-September amid the growing divergence between the US and Canada.

The European Commission has cleared payment of some €800 million of post-pandemic recovery funds it withheld from Slovakia over concerns with the rule of law in the country. The EC formally unblocked the funds already back in July after the Fico government reinstated sentencing for fraud with EU resources. But it stopped short from transferring until after parliament had approved changes to its criminal code which reduced sentences for crimes ranging from petty theft to fraud. The Fico’s government in the meantime reassured Brussels that the amendments do not eliminate the prosecution of crimes related to EU Funds. The EC responded that some of its concerns have been alleviated though adding that talks are ongoing to “clarify the pending issues”.