Rare situation in monetary policy

We are about to experience a rare situation in monetary policy: the European Central Bank could cut its benchmark rate before the Federal Reserve. This would be the first time since the early 2000s. At the start of this year, the market was expecting the ECB to cut rates slightly more than the Fed: expectations were for 6 cuts in the US and between 6 and 7 in Europe.

As we approach the middle of the year, where do we stand? Neither country has yet cut its benchmark rate, and among the G10 countries, Switzerland was the first to begin a cycle of monetary easing. In Europe, the market is expecting a rate cut in June, but the picture for the United States is less clear: while some expect a cut in July, the implied probabilities in futures contracts do not point to a cut before November. This may be followed by a second cut in December, with a probability of 50%. This means that Europe could cut rates further and faster than the United States in 2024!

One of the cruxes of this difference lies in inflation and the perception of its evolution. While the ECB says it is ‘really confident’ that inflation is ‘under control’, the story is different for the Fed. Since the inflation figures for April, published in mid-May, came in slightly below expectations, the Fed has been tempering market expectations about the timing and scale of future rate cuts. A plethora of central bankers are speaking on the subject, with a common thread: it will take more than a single piece of data to ensure that inflation is under control and that the cycle of monetary easing can begin ‘later this year, or early next year’.

In other words, volatility is the order of the day, and bond yields are swinging regularly, like the US 10-year, which started the year at 3.89%, climbed to 4.70% at the end of April and is currently at 4.43%. Although expectations are different, the performance of government bond markets is similar: -1.56% in the United States and -1.39% in Europe. In Europe, the disparities are considerable: -2.57% in Germany compared with +0.58% in Italy, which has benefited from a tightening of its risk premium. In Switzerland, the bond market is doing ‘less badly’ but remains in negative territory this year at -0.91%.

Between the central banks that have already cut their rates (Switzerland), those that are preparing to do so (Europe) and those that are stalling (United States), it is interesting to note that their bond markets are steering their course without fully incorporating expectations of rate cuts, and close to their highs of recent years, bond yields still offer good entry opportunities for investors who have not yet taken the plunge and bought bonds.