The downward trend in inflation is quite clear

Author: Mauro Valle, Head of Fixed Income, active management, at Generali Asset Management

After last CPI (Consumer Price Index) data in US and Eurozone, we believe this trend is not at risk in the long term, but there is the possibility that the decline in “the last mile” should be bumpy. This is true especially for the US, as economic growth is expected to be positive in the next quarters and the labour market is not yet showing signs of weakening. Last core inflation data is slightly below the 4% (3.9% in February), showing a deceleration of decline. As a consequence the market is pricing only 3 cuts by FED within December. The probabilities that Powell will not start with the cutting cycle in June are increasing.

In Eurozone the scenario is quite different, as euro economy for the moment is still stagnant, as confirmed by last PMI data. In the last meeting the ECB revised down their inflation forecast for 2025, now in line with their target of 2%. The ECB seems to be oriented to cut official rates in June and the last ECB members speeches seem to confirm these expectations. Our research is confirming the view of a first 25 bps rate cut by June and then cumulative cuts for 100 bps in 2024, as expected by the market. Given the weak macroeconomic context, there are conditions to consider an early start in April, but ECB is preferring to take more time to ensure that upcoming inflation data does not present negative surprises. The key variables to monitor are the confirmation of the inflation decline (and wages trend) and to see if the euro economy will improve as expected in second half of the year.

The coming weeks may present tactical opportunities for euro governments bonds, as core rates, after the retracement observed from the beginning of the year, are moving again in the high part of the range observed in the last months. We believe that German rates close to the level of 2.5% are offering an opportunity to go be exposed to interest rate risk. This is true especially for short – medium maturities, as the euro yield curve is inverted, and it’s expected dis-invert (or at least reset the inversion) when the cutting cycle will start.

About BTPs, that performed quite well in the last weeks vs German bond, we can observe there are a couple of reasons that supported the performances.  Considering market factors, we have seen a large appetite for risky assets and that is positive for bond credit spreads and Italian bonds. The search for carry is strong from market, as it ‘s expecting lower yields in the future. But also factors related to Italy are supportive for Italian spreads: a stable outlook by rating agencies, the Italian growth is better that euro average (and it’s noteworthy that Italian economy is not suffering of the weakness of the German situation), lower rates that will limit future interest expenses. Finally we can consider also that, at the beginning of the year, investors were worried about the net amount of  bonds to be issued in 2024, but in that firsts months of 2024, demand was strong and retail support large again; so Italian issuance activity is funded quite well at this point of the year.