Has market repricing of Central Banks gone too far?

Following solid US economic data and sticky inflation prints, markets are now pricing less than two rate cuts this year and see the easing cycle ending above 4%, 150bps above the Fed’s estimated neutral rate. Moreover, despite disinflation in the euro area, markets doubt that the ECB will lead the Fed in the easing cycle. In our latest Market Perspectives, we argue that markets may be turning overly pessimistic on central banks. The US labour market is rebalancing which will cool wage growth and new tenant rents point to a moderation of housing costs. The Fed will wait for more reassuring data and we expect the first of the two rate cuts for this year in September. Fears that the ECB will wait for the Fed seem overblown as a June cut has been already telegraphed. We are not overly worried by the exchange rate: only a big knock to the trade-weighted euro would seriously affect inflation. We still have 75-100bp of ECB cuts in our book for this year.

Easing inflation, prospective rate cuts and a US soft landing are behind our call to moderately increase duration exposure. Global economic green shoots and bumpy US inflation keep the risks to yields two-sided in the short term, though. But we see 10-year US Treasury yields above 4.60% as a good entry level. A brighter economic outlook will support corporate earnings, but geopolitical risks and still optimistic valuations leave us neutral on riskier segments (Equities and High Yields). Anticipating stable spreads on high-quality names, we prefer EUR IG Credit financed by underweights in Cash and short-dated govies.