We rarely see US and euro rates diverge as much as on Thursday, but the bullish move from the US won eventually. Nevertheless we see two very different rates markets, and thus seeing more days with diverging moves is likely. The Fed has many more cuts imminent, whereas the European Central Bank is in a holding pattern. At the same time the growth outlook for the eurozone is one of recovery, while jobs market woes dominate the US narrative. We still think the 10Y euro swap rate can drift higher over the near term and diverging moves like we saw today show that EUR rates may even manage this in a UST bull market. Especially if the eurozone growth recovery keeps up, the 10Y swap rate could start eyeing 2.8%.
Having said that, the 10Y EUR rate may not continue drifting higher if a further deterioration in US data starts hurting global risk sentiment. But with the S&P 500 hitting new records in response to Thursday’s disappointing US data, that doesn’t seem to be the case for now. Another risk is a further escalation of the French political turmoil, yet even then the spillovers beyond French government bond yields have so far been contained.
With a view to the EUR front end our economists no longer view a rate cut as the central scenario for the ECB. Nonetheless, the ECB has not fully closed the door to further easing. The market has reduced its prospects for another cut with the easing priced by mid next year pared back to 12.5bp, making it basically a coin toss. The 2y Schatz yield briefly hit the 2% level. As we have stated before, at a level close to 2% we see on balance more reasons for rates to go lower than higher in the coming months.