Rates Spark: Hawkish sentiment helps the long end stay anchored

Articles Rates Spark: Hawkish sentiment helps the long end stay anchored 07:35 Rates Spark Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Despite lower oil prices, markets are holding onto the prevailing hawkish narrative, limiting the downside risks to rates. Hawkish central bank pricing actually helps contain the upside risks to longer rates, as long-term inflation expectations are kept well-anchored to 2% Benjamin Schroeder Markets are holding onto a hawkish narrative, despite the sharp drop in oil prices No reason for the ECB to fight the hawkish market sentiment Oil prices are settling on lower levels with the Memorandum of Understanding having been signed. While it is only the start of a lengthy negotiation process, market optimism seems to outweigh any lingering concerns for now.

Central bank rate expectations had already started to decouple from the level of oil prices earlier, but Thursday did see the floor that markets see for the European Central Bank rate reasserting itself. Despite oil marking its lowest price since the beginning of March, money markets continue to firmly price in another hike from the ECB to be delivered in September or October. The hawkish shift from the Fed the night before did spill over, but the decoupling had started earlier, with ECB officials maintaining a hawkish tone after the ECB meeting despite the easing geopolitical situation.

The latest prominent official to do so was the ECB’s Chief Economist Philip Lane, who suggested that the estimate of the neutral rate had shifted higher towards 2.5%. This would imply that the economy could well withstand another increase in the policy rate as the ECB still foresees “a prolonged period of above-target inflation” despite energy prices already coming down. Separately, Pierre Wunsch cautioned today that a second hike would be possible to "be on the safe side".

Uncertainty on the geopolitical front remains, and the ECB might be reluctant to change its direction having just delivered a rate hike. Sticking to more hawkish communication also ensures that higher market rates will continue to do their part in containing inflation. Lower long-term inflation expectations are helping to contain 10Y UST yields Longer rates are showing an interesting dynamic.

As inflation expectations remain low, real rates are holding at higher levels. Of course, this is also a pattern we have observed in the past and more prominently in the US, where the macro backdrop has proven surprisingly resilient overall. But it appears that Kevin Warsh's first meeting as Fed Chair has calmed some fears that he is a Trump-installed dove.

It is still early days for him, but as we have pointed out, the central bank’s credibility is ultimately what helps control the long end. Even now 10y US Treasury yields are only marginally higher compared to where they were going into the meeting, with the decline in inflation swaps having balanced out the rise in real rates. It appears President Donald Trump is better served by the Fed Chair firmly keeping an eye on the inflation mandate.

Friday’s events and market view In the UK, eyes will be on Gilts given Andy Burnham's decisive win in the Makerfield by-election, paving the way to a challenge to Prime Minister Keir Starmer's premiership. There are only a few data points to watch following the UK retail sales in the morning. The US is on holiday for ‘Juneteenth’, leaving the main focus on a still busy slate of ECB speakers.

We will hear from Chief Economist Lane again, but there will also be speeches by José Luis Escriva, Piero Cipollone, Frank Elderson and Emmanuel Moulin. In primary markets, Italy will conclude its sale of the BTP Italia Si retail bond for which the Tesoro has already collected orders of close to €8bn so far this week. Rates Daily 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 Benjamin Schroeder Senior Rates Strategist Benjamin Schroeder is a senior rates strategist at ING in Amsterdam. Before joining ING in 2016, he worked in fixed income research at Dresdner Kleinwort and Commerzbank in Frankfurt, Germany.… In this article No reason for the ECB to fight the hawkish market sentiment Lower long-term inflation expectations are helping to contain 10Y UST yields Friday’s events and market view