European markets experienced a slight decline on Wednesday as investors hesitated on their earlier predictions of imminent interest rate cuts by major central banks. Despite numerous attempts by various European Central Bank (ECB) speakers over the past weeks to counter prevailing market expectations, it seems only Christine Lagarde has been successful in injecting some rationality into the situation.
During an interview at Davos, the ECB President indicated that the central bank's initial rate cuts are likely to occur in the summer. Lagarde emphasized the need for additional evidence of disinflation before justifying a more accommodative policy. Knot, a member of the Governing Council, also commented that markets have exaggerated the anticipated extent of rate cuts, unintentionally causing financial conditions to loosen and raising the risk of a necessary hawkish response from the central bank. This warning echoed other hawkish signals observed earlier in the week.
Despite the mixed messaging, the Governing Council did find common ground on one aspect – there won't be any rate cuts in the immediate future. Consequently, Eurozone bond yields rose across the curve as markets scaled back their expectations of rate easing by the ECB. The likelihood of a rate cut in April decreased to 75%, and money markets adjusted their cumulative rate cut projections for 2024, pricing in 134 basis points (-16 basis points day-to-day) of easing. This translates to five quarter-point cuts, a reduction from the six cuts anticipated the previous week.
In summary, the Stoxx 50 index dropped 1.2% to its lowest level since late November, and the German 10-year Bund yield continued its ascent to 2.3%, reaching its highest level since December 8th. The optimism for rate cuts wavered, leading to these market movements. Concurrently, the euro depreciated against the US dollar for the fifth consecutive day, settling around the 200-day Simple Moving Average (SMA) of $1.0850s – a fresh 5-week low driven by overall USD strength. In other currency pairs, EUR/GBP hit a 1-week low as the British Pound rebounded following higher-than-expected December UK CPI figures. Despite the confusion in ECB messaging, the common currency benefited against most other G10 peers, with EUR/JPY and EUR/CHF gaining 0.6% and 0.5% day-to-day, respectively.
