HEWG - Are Peak German Rates Within View?
2023-11-14 00:50:00 ET
Summary
- Easing services data and reduced government funding needs could lead the ECB to switch to a dovish policy.
- The most recent decline in bond markets began in mid-September, pushing the German 10-year government rate up close to 3%.
- The last meeting of the European Central Bank provided hope for an end to its tightening cycle.
By Patrick Barbe
Easing services data and reduced government funding needs could lead the ECB to switch to a dovish policy.
The most recent decline in bond markets began in mid-September, pushing the German 10-year government rate up close to 3%. However, this trend was reversed at the end of October, bringing the rate back toward 2.6%.
Relatedly, the last meeting of the European Central Bank provided hope for an end to its tightening cycle .
The market appears to believe that the euro bond rates have likely seen their peak and could even fall next year: Key drivers of higher market yields include economic resilience and heavy government funding needs, both of which are starting to ease.
The euro bond sell-off in September emerged from the U.S., where economic growth exhibited strength despite weak leading and confidence indicators.
Similarly, in the eurozone, forward-looking indicators raised fears of a major recession, although, so far economic figures only reflect a technical recession.
The latter is largely due to resilience in the service sector, supported by summer tourism and household savings from the COVID period.
However, these effects are fading, with the latest hard data showing a deterioration in service activity amid tightening credit conditions.
In turn, the consensus for a weak economic recovery at the start of next year is losing ground, raising the question of whether the ECB overreacted in its hawkish monetary policy and should soon start cutting rates.
In the short term, tensions as to rates have been amplified by a heavy primary market ahead of year-end. The extension of public aid put in place to fight the consequences of the COVID pandemic and then last year’s energy crisis led to a surge in financing needs.
However, the end of these crises has prompted most governments to start reducing their spending, leading to their planned reduction of over €50 billion in gross supply (or €150 billion in net supply) for 2024.
The market feared that this would be more than offset by the ECB's acceleration of quantitative tightening, but during the last committee meeting, QT did not even come up, likely postponing this risk until the second half of 2024.
In our view, the potential end of rising German bond rates is within view, potentially stabilizing between 2.5% and 2.75%. However, any decline may be hampered by the currently flat yield curve.
Over time, the driver of lower German rates will likely be the trajectory of eurozone core inflation. If it falls below 4%, that should lead to more dovish policy from the ECB.
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Are Peak German Rates Within View?