Transatlantic decoupling but not for much longer

Fixed income markets continue to be characterised by large daily fluctuations, and the past month has been no exception. US rates rose noticeably in the wake of the elections in early November, but the reaction has gradually faded since then. At the time of writing, the 10-year US Treasury yield is trading very close to 4.25% - roughly the same level as before Election Day on 5 November. In contrast to the US, European rates have declined due to weak growth indicators, political uncertainty, and the threat of an imminent trade dispute with the US.

No market panic following the US election result

We had anticipated a greater impact in the wake of a 'Republican Sweep', but several factors have allowed for cautious optimism in the bond market. First and foremost, the Republicans' majority in the House of Representatives, one of the two chambers of Congress, appears to be razor-thin (220 against 214), which could hinder at least the most far-reaching fiscal proposals. Another factor is Trump's cabinet appointments, where, among others, the nomination of longtime Wall Street veteran and economist Scott Bessent as Treasury Secretary indicates that Trump is mindful of the financial side effects of his policies. However, many questions about next year's policies remain open, especially regarding trade policy, which is among the first areas where Republicans can deliver on election promises. Trump has already before his inauguration promised to raise tariffs on Canada, Mexico, and China, under the pretext of the US's problems with illegal imports of the opioid substance fentanyl. Rates markets seem prepared for such announcements, and the reaction has been subdued.

Until we have greater clarity on the political outlook, all focus in relation to US rates will be on the economic data, which since the beginning of October has consistently surprised to the upside. Concerns about the labour market's condition have moderated, clearly steering signals from the central bank's members towards a more patient approach to easing monetary policy. However, it is important to keep in mind that uncertainty about the US labour market has not disappeared, and in our view, it will keep the Fed on the easing track. We foresee the Fed delivering another rate cut of 0.25pp at the December meeting and five additional cuts of the same magnitude next year. Thus, by the end of 2025, the policy rate—the Fed Funds Rate—will be approximately 1.50pp lower than today. The market is expecting just 0.6pp over the same period.

The decline in European rates driven by several factors

In the Eurozone, rate developments during October have been the exact opposite of the US trend. Weak growth indicators in November and the threat from Trump's protectionist stance have intensified expectations that the ECB could shift to a higher gear in the normalisation of monetary policy at the December meeting. Currently, there is a significant 20% probability priced in that the rate cut could be as large as 0.50pp. In our view, the risk of this outcome is real, but for now, we maintain our expectation for the smaller reduction of 0.25pp. Much will depend on how the governing council views the risk outlook for inflation and growth in 2025 and 2026. Here, we assess that the arrow still points towards weak growth and a now more limited upward risk to inflation.

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