Government bonds in Europe surged sharply on Tuesday, as market traders positioned themselves for faster interest rate cuts as signs grew that the region’s economy needed looser monetary policy. French bonds led this move, driving the 10-year yield to its lowest level since March, while US Treasuries followed the trend, with the 10-year yield falling four basis points.
This market shift came after European Central Bank (ECB) member Olli Rehn hinted that the bank would consider further rate cuts at its next monetary policy meeting this month. Rehn is the latest among monetary policymakers to suggest the possibility of consecutive reductions, which has accelerated traders’ bets on a more aggressive than anticipated global easing cycle.
Pressure on ECB increases as inflation falls below 2%
The ECB faces increasing pressure to act as the latest data shows inflation in the euro zone fell below the 2% target for the first time since 2021 in September. This data reinforces the idea that economic activity is cooling and that the inflationary pressures that have affected economies in recent years are returning under control.
Furthermore, the outlook for the manufacturing sector in the euro zone’s largest economy, Germany, is particularly bleak. The government in Berlin is about to revise down its economic growth forecast for this year, with the economy expected to barely avoid recession after a contraction in 2023.
Forecasts of rate cuts and adjustment of expectations
A 25 basis point cut by the ECB in October, which a few weeks ago was considered a marginal risk, is now almost fully priced in by the market. Banks including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Barclays have revised their forecasts, now anticipating a cut in October instead of December.
In the United States, money markets are implying a one-in-three chance that the Federal Reserve will deliver another half-point cut in November, with a total of 190 basis points of easing expected by the end of next year.
In summary
Growing economic weakness in the euro zone, coupled with inflation falling below the ECB’s target, has intensified expectations of rate cuts, with European bonds rising in response. With markets adjusting for a more aggressive global easing cycle, the ECB and Fed will have to balance the need to support economic growth while keeping inflation in check.
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