USD yields peaking now, potential ECB rate hike in May

Danske Research Team Danske Bank A/S

The banking turmoil that erupted in the wake of the collapse of Silicon Valley Bank (SVB) five weeks ago has subsided as a market theme as the string of negative news has come to a halt. As a result, with traditional stress indicators declining, the focus has increasingly moved to the macro narrative, as we also discussed in our previous Yield Outlook - Uncertainty about US banking sector clouds rate outlook, 17 March.

The ‘normalisation’ of the rate outlook means that markets are currently trading two major themes which we also expect to set the tone for rates markets in coming months. While ‘Dollar Land’ is already discussing the first US rate cut, we expect the Federal Reserve to deliver a final 25bp rate hike at the upcoming May meeting and then to keep policy rates unchanged until Q1 24, when a gradual rate cutting cycle will likely commence. As regards the eurozone, discussions about rate cuts are still premature. We continue to expect a further string of rate hikes, with a 50bp hike in May followed by 25bp hikes in both June and July, bringing the peak policy rate to 4%. This is somewhat above the current market pricing of a 3.75% peak policy rate. The biggest risk to our forecast of a 4% peak policy rate hike is whether the ECB will deliver a 25bp or a 50bp rate hike in May. Markets are currently pricing 32bp for May. The economic backdrop for our central bank calls is presented in the Nordic Outlook - Unchartered territory, 4 April.

As a result, we see longer-term USD yields peaking ‘now’ and expect them to stay around current levels until autumn this year before starting to decline gradually, reflecting the expected easing cycle in 2024. The USD curve is currently heavily inverted due to markets expecting the Fed to start easing monetary policy as early as this summer. At the time of writing, markets are pricing three rate cuts of 25bp each between June and December this year. While we do not share this view, we do not expect a significant repricing posing considerable upside risk to longer-term USD yields, as markets are focusing on the next big move in rates markets, which is likely to be for lower rates. Historical evidence shows that, on average, the Fed has started cutting policy rates three quarters after the last rate hike. We currently expect a first rate cut from the Fed in Q1 24 followed by a sequence of cuts at a pace of one cut per quarter through 2024. This should likely support the lower rates narrative starting in autumn this year in anticipation of monetary policy easing.

As for the eurozone, we continue to see modest upside risk to longer-term yields on a 3M horizon in a curve flattening move, as the ECB is yet to show a strong hand in fighting the high underlying inflation prints, taking the front end up relative to the long end. We expect eurozone markets to start discussing and pricing 2024 rate cuts from the ECB towards the end of this year, trailing US markets slightly. This is likely to support longer-term yields on 6M-12M horizons. We project an ECB rate cutting cycle starting in summer 2024.

While the very high volatility in rates markets we observed one month ago has subsided somewhat, volatility has remained at elevated levels, and markets are currently pricing 10Y EUR swap rates in a broad 3.5 percentage point range by the end of our projected horizon (with a 90% probability).

Download The Full Yield Outlook

Author

Danske Research Team

Danske Bank A/S

Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.

EUR/USD hits two-day highs near 1.1820

EUR/USD picks up pace and reaches two-day tops around 1.1820 at the end of the week. The pair’s move higher comes on the back of renewed weakness in the US Dollar amid growing talk that the Fed could deliver an interest rate cut as early as March. On the docket, the flash US Consumer Sentiment improves to 57.3 in February.

GBP/USD reclaims 1.3600 and above

GBP/USD reverses two straight days of losses, surpassing the key 1.3600 yardstick on Friday. Cable’s rebound comes as the Greenback slips away from two-week highs in response to some profit-taking mood and speculation of Fed rate cuts. In addition, hawkish comments from the BoE’s Pill are also collaborating with the quid’s improvement.

Gold climbs further, focus is back to 45,000

Gold regains upside traction and surpasses the $4,900 mark per troy ounce at the end of the week, shifting its attention to the critical $5,000 region. The move reflects a shift in risk sentiment, driving flows back towards traditional safe haven assets and supporting the yellow metal.

Crypto Today: Bitcoin, Ethereum, XRP rebound amid risk-off, $2.6 billion liquidation wave

Bitcoin edges up above $65,000 at the time of writing on Friday, as dust from the recent macro-triggered sell-off settles. The leading altcoin, Ethereum, hovers above $1,900, but resistance at $2,000 caps the upside. Meanwhile, Ripple has recorded the largest intraday jump among the three assets, up over 10% to $1.35.

Three scenarios for Japanese Yen ahead of snap election

The latest polls point to a dominant win for the ruling bloc at the upcoming Japanese snap election. The larger Sanae Takaichi’s mandate, the more investors fear faster implementation of tax cuts and spending plans.

XRP rally extends as modest ETF inflows support recovery

Ripple is accelerating its recovery, trading above $1.36 at the time of writing on Friday, as investors adjust their positions following a turbulent week in the broader crypto market. The remittance token is up over 21% from its intraday low of $1.12.