Rates: Dealing with the rate hike narrative
The desk posits that while the market may be pricing in aggressive rate hikes, a more moderate approach is warranted based on the current rate hike narrative. Per the full note by Padhraic Garvey at ING, the desk suggests that even though hikes may not fully materialize, the anticipation and positioning toward the hikes will drive market dynamics. This perspective is especially relevant for the EUR/USD pair, where it appears the market is leaning towards a 25 basis point hike from the ECB, pushing the deposit rate toward 2.75% over the next year, despite skepticism about the delivery of all projected hikes. With the current EUR/USD trading at 1.1679 and firm targets indicating a December consensus around 1.2000, there is room for volatility in response to ECB messaging and the rate environment.
What the desk is arguing
The desk argues that the market's expectation of multiple hikes, particularly from the ECB, should be met with caution despite current projections. The emphasis is placed not on the realization of these hikes but rather on the market's discount and its subsequent influence on rates. Per the full note, the EUR/USD could reflect various shifts in sentiment around the ECB's actual policy moves.
Current market dynamics indicate a potential stabilization in the 10-year eurozone rate near 3%, which is considered a modest valuation against a backdrop of 3.2% headline inflation. This suggests that while there is cushion for further upward adjustments, the trajectory may remain range-bound unless deeper inflationary pressures or substantial growth prompts a reassessment of this narrative.
Where it sits in our coverage
Our current consensus target for EUR/USD stands at 1.2000 for December 2026, with a range from 1.1200 to 1.2000. Specific firm targets include: - Commerzbank: Dec-26 1.2200 - Barclays: Dec-26 1.2100 - BNP Paribas: Dec-26 1.2100
This aligns with views across the board, with the desk's stance sitting comfortably within the upper range of projections. With the consensus leaning towards bullish sentiment on EUR/USD, any notable shift in ECB policy could see immediate adjustments in this outlook.
How other firms see it
Analysis from aligned firms indicates a supportive view toward the EUR, highlighting potential upside pressures as the ECB moves forward with its rate hike narrative. Firms such as Mizuho and Rabobank are similarly optimistic, sharing tight targets around the current consensus. In contrast, firms like Wells Fargo and Nordea present a more cautious outlook, proposing conservative targets for EUR/USD that suggest a firmer stance on dollar strength.
Moreover, monitoring GBP/USD trends could provide insights into the interconnectedness of central bank decisions, especially as the BoE signals its own rate path adjustments amid varied inflationary pressures. Similarly, the USD/JPY trajectory could be crucial to watch, given its potential for spillover effects from U.S. monetary policy deliberations.
How firms align with this view
Key takeaways
- 01The desk views market pricing of ECB rate hikes as excessive relative to potential delivery.
- 02Current EUR/USD trading levels suggest volatility ahead of ECB policy nuances.
- 03The consensus target of 1.2000 for EUR/USD indicates room for upward movement.
- 04Price action may reflect the delicate balance between inflation rates and central bank actions.
Market implications
Monitor EUR/USD as it approaches the consensus target of 1.2000, particularly in the context of the upcoming ECB communication. How markets react to the narrative of rate hikes could significantly influence positioning and volatility in the pair.
Risks to this view
A turnaround in this call could be prompted by a more aggressive ECB stance than anticipated or surprising economic data that significantly shifts the rate outlook, warranting a recalibration of current targets and sentiment.
Articles Rates: Dealing with the rate hike narrative 10:32 Rates Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download We're less aggressive than the market on rate hikes, but for now, it's best to position for the maintenance of material rate hike risks. Delivery of hikes is important, but not determinative, as the mere discount for hikes can be just as impactful. At the same time, we note that curve structures are, in fact, not discounting significant cumulative hikes Padhraic Garvey, CFA The market discount for hikes matters as much as actual delivery The market is discounting a series of hikes, but also signalling that the ECB can't go too far The market discount for rate hikes has intensified, and the European Central Bank is set to validate part of that discount later today (25bp rate hike expected, the first hike in more than two and a half years).
The market discount has the deposit rate trending to the 2.75% area within the next 12 months. While we are doubtful that the ECB will deliver all of these hikes, from the perspective of mapping out the rates curve, it actually does not matter much. What matters is where the front end is pitched, which is driven by the market discount for hikes.
Bottom line: the eurozone rate curve is initiated at around 2.75%, and longer tenors are built on top of that, e.g. the 2yr Euribor rate is bang on 2.75% currently. When we look at the 10yr rate, we find it trading at or around 3%. That's actually quite a tame valuation considering eurozone headline inflation is running at 3.2%.
It's for this reason that we continue to expect eurozone 10yr rates to continue to hug the 3% area, with, if anything, a tendency to edge higher. In fact, we think it should remain above 3% for the coming months at least. We also find that the 5yr part of the curve is trading a tad rich, meaning the 5yr rate trades below the interpolated line drawn between the 2yr rate and the 10yr rate.
Typically, when the 5yr trades rich to the curve, the market is more tuned towards cuts than hikes. The latest 5yr 'richness' tells us that, while the market may be discounting rate hikes, the structure of the curve tells us that subsequent rate cuts are also being contemplated. How to interpret this?
Well, either the ECB does not hike as much as the market discounts (ING baseline view), or if they do, there would be the need for a bigger subsequent unwind. The 10yr Treasury yield to hold in the 4.5% area, with upside tests a genuine risk In the US, there is no rate hike discounted for the June or July meetings. It's from the September meeting that a rate hike discount really builds, and even then, it's a 50:50 call.
It's the December meeting that has a full 25bp hike discounted, and the market attaches a high probability to that hike being delivered as early as the October meeting. Essentially, this pitches the front end of the curve in the 4% area. We build the curve from here.
The 10yr SOFR rate, at 4.15% currently, is in fact quite tame against that. And especially when we consider that US headline consumer price inflation is also in the 4% area. Interestingly, the structure of the US curve also features the 5yr rate trading through an interpolated line from the 2yr to the 10yr rate.
This 'rich' 5yr valuation is consistent with either no hike from the Fed at all, or if the Fed does hike, it will subsequently find itself cutting quite quickly thereafter (a matter of months). Given this, and adding the notion that an elevation in real yields has a longer-term rationale centred on the tech revolution (arguably tenuous, but there; see more here ), we're comfortable with the 10yr yield hugging the 4.5% area. That's the type of environment we anticipate for the coming months, in fact with some upside risks.
Inflation expectations are quite tame in the 10yr, and have room to edge higher in the coming months should the Strait of Hormuz remain closed. Last month, we identified the 4.75% area as a risk for the 10yr yield, and we stick with that (we've already spiked to 4.7%). The baseline view, though, is we hug the 4.5% area and trade around that.
US rates Eurozone rates Content Disclaimer This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Author Padhraic Garvey, CFA Regional Head of Research, Americas Padhraic Garvey is the Regional Head of Research, Americas.
He's based in New York. His brief spans both developed and emerging markets and he specialises in global rates and macro relative… In this article The market is discounting a series of hikes, but also signalling that the ECB can't go too far The 10yr Treasury yield to hold in the 4.5% area, with upside tests a genuine risk
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