We have tweaked our USD rates forecasts lower and our EUR rates forecasts higher. For the US, despite lingering strength in the labour markets and elevated inflation prints, we have turned wary of financial system risks after the string of bank failures over the past few months.We have pulled forward the timing of Fed cuts into 1Q24 and see stabilization of the Fed funds rate (upperbound) at 4% in 3Q24 (see here). Note that this view is contingent on stability in the banking system and a soft landing gets engineered. The market is clearly a lot more cautious, factoring Fed cuts as early as 3Q23. However, we would note that the market probably weighting several scenarios and there is always a chance of a hard landing triggered by more bank failures that would require the Fed to pivot much more aggressively. On the other side of the coin, a managed slowdown would probably allow the Fed to focus more on inflation. Overall, we think demand for protection would likely keep US yields depressed versus fundamentals for some time.Risks are still modestly tilted towards Fed cuts in late 2023.
For the Eurozone, there are differences even as both economies are displaying considerable data resilience. First, the ECB is slower than the Fed in this cycle. Accordingly, with CPI prints still more elevated than the US, there is reasonably more runway for the ECB to hike. We now see the ECB’s Refi rate peaking at 4.00% (some risks to the upside) this cycle. Further out, we also see rate cuts in 2Q24 later than what we expect from the Fed (1Q24). Second, the European banking system has thus far been stable. Even as some caution is needed, we do not think that the ECB has to tread as cautiously as the Fed. In any case, the hike cycle is probably mature. As the economic recovery ages, we doubt that there will be leeway to tighten later than 3Q23. Overall, the market is slightly more hawkish on the ECB than we have pencilled in.
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