Column-US, euro rate path set to diverge ... finally: McGeever
By Jamie McGeever
ORLANDO, Florida (Reuters) — It's been a long time coming, but the remarkably tight correlation between U.S. and euro zone interest rate expectations is set to unravel.
The European Central Bank's downward revisions to its growth and inflation outlook on Thursday speak to an economic reality that means the ECB's rate-cutting cycle will start soon, despite President Christine Lagarde's protestations to the contrary.
The U.S. economy, on the other hand is running hot and signs are emerging that some price pressures are re-accelerating. Speculation is growing that the Federal Reserve could raise its long-term 'neutral' interest rate projection later this month.
Understandably, officials from both central banks have leaned against these narratives — the ECB doesn't want to lose its inflation-fighting credibility, and the Fed doesn't want to crash the economy's 'soft' or 'no landing'.
The rhetoric from Fed and ECB officials, aimed at giving themselves as much flexibility as possible, has struck a common tone. As a result, the expected path for U.S. and euro zone rates this year and into 2025 has been almost identical.
The correlation between short-dated U.S. and euro zone government bonds has never been stronger, shackling the euro/dollar exchange rate and depressing FX and bond market volatility.
It's a merry dance that financial markets have played along with. But for how much longer?
«ECB policymakers have been pushing back hard against the idea of rate cuts, maybe as part of a futile effort to support the exchanges rate. But this can't go on much longer, maybe a couple of months,» said Dario Perkins, global macro strategist at TS Lombard.
«Reality will set in, for the ECB and markets,» he added.
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