After the recent banking turmoil, global rates markets are beginning to show signs of normalisation, with traditional stress indicators declining. As a result, the focus has shifted to macro narratives, with longer-term USD yields expected to peak before gradually declining in anticipation of an easing cycle in 2024.
Although discussions about rate cuts in the eurozone are still premature, the expectation is for further rate hikes with a peak policy rate of 4% by July. This is above the current market pricing of a 3.75% peak policy rate. The biggest risk to this forecast is whether the ECB delivers a 25bp or a 50bp rate hike in May.
The current heavily inverted USD curve is due to markets expecting the Fed to start easing monetary policy as early as this summer, with three rate cuts of 25bp each between June and December this year currently priced in. However, historical evidence shows that, on average, the Fed starts cutting policy rates three quarters after the last rate hike. The expectation is for the first rate cut from the Fed to occur in Q1 24 followed by a sequence of cuts at a pace of one cut per quarter through 2024.
While volatility in rates markets has subsided somewhat, it remains at elevated levels. Markets are currently pricing 10Y EUR swap rates in a broad 3.5 percentage point range by the end of the projected horizon, with a 90% probability. As such, it is expected that eurozone markets will start discussing and pricing 2024 rate cuts from the ECB towards the end of this year, trailing US markets slightly. This is likely to support longer-term yields on 6M-12M horizons.
Overall, global rates markets are showing signs of normalisation post banking turmoil, with longer-term USD yields peaking 'now' and expectations for a gradual decline in anticipation of an easing cycle in 2024. Meanwhile, modest upside risk is expected in longer-term yields on a 3M horizon in a curve flattening move in the eurozone.
