ECB Set To Test Market Positioning On Rate Trajectory
By Ven Ram, Bloomberg Markets Live reporter and strategist
Front-end German bonds have so far resisted the upside risk to the European Central Bank’s rate trajectory. That may not last.
The two-year yield has been bobbing in a 2.50%-3% range for a few months, even though interest-rate traders are factoring in a higher terminal rate than they were at the start of the year. These points are what traders are watching for:
Statement:
- Markets are positioned for a 25-basis point increase, and there is little risk that the ECB could disappoint on the quantum. In fact, there is a heightened risk that the monetary authority may sound more hawkish, especially after the Fed’s guidance on Wednesday
- The key to the markets’ reaction will be any significant change(s) to this part of its statement from March:
“The Governing Council’s future decisions will ensure that the policy rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary. The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction.”
- If the statement suggests that the ECB has reached the last lap of tightening, bonds would latch on to that to rally. On the other hand, any tweak in the language that suggests inflation is stickier will spur traders to price in a terminal rate that takes it toward 4%.
Macroeconomic projections:
- Inflation has averaged 7.4% this year, well above the ECB’s estimate of 5.3%. That, of course, raises the question of whether the monetary authority will stick to its projection or concede that inflation win run higher. The latter would raise conviction that rates will need go higher and stay there longer, in turn underscoring the upside risk to yields.
- The recent slowdown in survey readings, weak industry data and rapidly tightening credit conditions suggest downside risks to GDP growth projections, colleague David Powell reckons
All told, the markets are ill-prepared for the ECB raising rates much higher than 3.75%, and it’s possible that today’s policy review may provide a reality check on that pricing.
