Markets
Core bonds sold off today with German Bunds extending yesterday’s underperformance against US Treasuries and UK gilts. The ECB kept its policy rate unchanged at 2% for a second consecutive meeting with President Lagarde declaring the disinflation process being over and upgrading the risk balance around growth prospects to “more balanced”. This change in tone prompted a scaling down of remaining ECB rate cut bets, opening the discussion of what might come next after the current, likely extended, pause. Several ECB members added to the debate in overall fairly neutral comments. Summing up their views: the ECB decided by consent that doing nothing is the modus operandi from now on unless any other significant development challenges the outlook and calls for action. Depending on where the governor stood at the dove-hawk scale that might imply cutting or hiking. Anyway, markets consider the “cutting” door closed for now with the market implied probability of action before year-end dropping as low as 15% and the chance that we see another 25 bps rate cut in 2026 dipping to 40%. EU swap rates today add 2.2 bps (2-yr) to 5.9 bps (10-yr) with the belly of the curve outperforming the wings. The 2-y rate extends yesterday’s technical break to levels (2.15%) last seen around Liberation Day early April. The euro fails to profit from the interest rate support with EUR/USD slightly ceding ground at 1.1715. Daily change on the US yield curve range between +0.8 bps (2-yr) and +3.4 bps (10-yr) as US markets wait for more guidance coming from the Federal Reserve next week. A 25 bps rate cut – first since December – is the discounted base case but visibility about the path afterwards remains rather low. All else equal, we assume follow-up action in both October and December.
Later today, attention shifts to the US independent Congressional Budget Office which publishes its current view of the economy from 2025 to 2028. This report will present the CBO’s latest short-term projections for major economic indicators—including GDP growth, inflation, unemployment, interest rates, and consumer behavior. It will also discuss the agency’s updated demographic projections, effects of recent tariff policies, and effects of the 2025 reconciliation act. At the end of August, the CBO already updated projections of the budgetary effects of tariffs. The agency suggested that tariffs implemented (until August 19) will decrease primary deficits by $3.3tn if the higher tariffs persist for the 2025-2035 period. By reducing the need for federal borrowing, those tariff collections will also reduce federal outlays for interest by an additional $0.7tn. As a result, the changes in tariffs will reduce total deficits by $4tn altogether. This compares with an estimated $2.5tn impact in June prognosis. Together with Fed Chair Powell’s dovish pivot in Jackson Hole, this might help explain the recent outperformance at the long end of the US yield curve with the 10-yr tenor yesterday touching 4% for the first time since early April.
News & Views
The Bank of England’s quarterly survey on consumer inflation expectations showed the gauge for the year ahead rising from 3.2% to 3.6%, the highest in exactly two years. The two-year barometer picked up to 3.4% from 3.2% in the May questionnaire, a 14-year high. Asked about inflation over the longer-term, say five years, the respondents’ answer was 3.81%. That’s more than in the May survey (3.6%) and just enough for a new record high in the 16-year old series. The previous high dated from November 2013 (3.8%). When asked about the future path of interest rates, 33% of respondents expected rates to rise over the next 12 months, the same as in May, vs 29% saying they expected rates to decline, down from 34% in May 2025.
France’s statistical agency INSEE is forecasting marginally faster GDP growth than previously expected. Key sector such as the aeronautics industry, tourism, real estate and agriculture would rebound, allowing the economy to grow by 0.8% instead of 0.6% earlier. The good news came with an important disclaimer though. INSEE said growth was merely benefiting from a temporary boost of companies rebuilding inventories after two years of drawdowns. The French economic power engine, the consumer, is still idling. The shaky political situation isn’t helping to revive confidence either and combined with rising unemployment fears have instead caused consumers to save any spare cash rather than spending.
