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Breakfast Bites - The ECB's Hawkish Cut

Rise and shine everyone.

The big news today is the ECB’s first rate cut. With all the telegraphing that the ECB members have done about the June cut, there doesn’t seem to be a way to back out of it now without completely shooting down their credibility.

In other big news, NVDA hit the $3T market cap mark, leading the way for other chip manufacturers to soar as well. ASML in Europe, TSMC in Taiwan, and Advantest in Japan. With that the Nasdaq 100 also hit an all-time high and markets saw a positive close across the board.

Finally, the Bank of Canada also went ahead and did their first rate cut of 25bps for this cycle. There’s been mixed reactions to this with some saying that it’s too early and others breathing a sigh of relief for lower mortgage rates ahead. Much like the ECB though, I think the easing cycle will be shallow and cautious.

US Equity Futures are flat this morning, however. Markets are getting ready for tomorrow’s US Jobs report, which is expected to come in weaker after a weaker JOLTS and ADP number.

Commodities are also seeing somewhat of a bid with silver leading the way. UST yields are marginally higher but the 10-year remains at 4.3%, with a flat USD index.

Markets are likely to see continuation of yesterday’s price action, with the ECB’s cut as well. While the cut may be priced in, we’re likely to still see a move in European front-end rates lower, and equities higher. But, the reaction may be capped.

ECB’s Hawkish Cut

We expect a hawkish cut from the ECB. Given the way the ECB members have telegraphed this cut, there’s very little chance that this cut won’t happen. This will mark the 5th cutting cycle after a 9-month hold.

This is the first time in the 26-year history of the ECB, that they will cut when growth is positive and there’s no crisis.

However, in the meantime, we’ve received data that is slightly unnerving with inflation starting to pick back up again. A cut will weaken the EUR against the USD, and the GBP so we’re thinking at this stage, the messaging will continue to remain hawkish to avoid the EUR/USD hitting parity.

A higher for longer Fed means a stronger USD. Add to that, a tight labor market and base effects in Q3 which will continue to keep inflation firm, and we may not see any more cuts this year until December - unless perhaps the Fed starts cutting in July (highly unlikely at this stage).

We also receive the ECB staff projections which is likely to show small upward revisions to growth forecasts and inflation forecasts for 2024. 2025 and 2026 is likely to remain largely unchanged.

For some reason, the big question is can the ECB cut before the Fed? Well, it seems like they will this time. But, interestingly a look back at history tells us that there have actually been only two synchronized cycles between the ECB and Fed - 1999 to 2003 and this one, 2022 onwards. A look at the two rates shows this:

And finally the last thing to be addressed is the balance sheet. The TLTRO.III which was meant for bank lending will likely run-off by the end of the year with ease. The excess liquidity is about EUR 3.3T so the banks should be okay. But the purchase programs still remain enormous with the PEPP (Pandemic Era Purchase Program) at EUR 1.7T and is only just going to start rolling off by EUR 7.5B in the second half with reinvestment stopping by the end of the year. The ECB needs to step up their QT program, which they will likely do by 2025, so conditions won’t be as tight as one would expect.

Calendars

(news taken from Reuters, FT, Bloomberg; Calendar from Trading Economics)

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