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You go first, no I insist after you!

The bond market narrative has altered considerably this year. During 2022 and 2023, the major central banks were in lock step when raising interest rates and then putting them on hold. Recently, the convoy has started to break up – indeed over the course of April expectations grew that the ECB might be the first amongst the major economies to cut interest rates. There is speculation that the UK could move ahead of the Federal Reserve. Conversely it is getting harder for the US markets to ignore the repeated stalling of disinflation so expected moves on rates are being pushed further back in time.

Economic data helps explain this change of view. The US economy remains in buoyant mode, as demonstrated by the latest employment report. Further jobs growth and steady unemployment support wages growing about 4.5% from a year ago. Although small businesses remain under some pressure, and the housing market is suffering as mortgage rates exceed 7%, US economic growth looks on course for about 2-3% into the summer on the basis of recent retail sales and industrial production data. Despite some pull back in the latest business surveys, there is little in the data to suggest to the Federal Reserve that a marked economic slowdown is occurring.

Against such a backdrop, with headline inflation only slowly falling back towards target, it is understandable that Fed Governors prefer to wait and see. San Francisco Fed President Mary Daly said there is “no urgency” to cut rates as “the worst thing to do is act urgently when urgency is not required. We have to be thoughtful about not getting too confident that the latest sticky inflation is an indication where we are going forward, and we can’t get too confident that our projection that inflation will continue to come down is going to materialise”. Two other influential members, New York Fed President John and Chair Jerome Powell concurred that the recent data had not given them greater confidence and instead it is likely to take longer than expected to achieve that confidence.

Conversely, over this other side of the Atlantic, there are strong signals from the ECB that it will cut rates in June. Inflation in the Euro area is currently running only slightly above the Bank’s 2.0% target, and the economy is creaking under a tight monetary policy. Euro area bank lending remains weak, albeit the worst of the phase of outright contraction seems to be over. Consensus forecasts indicate economic growth could be under 1% across 2024.


There has been a pretty uniform message from ECB members. Governing Council member Francois Villeroy de Galhau said he cannot ignore the economic risks of keeping rates high for too long. The ECB should start cutting interest rates in June as inflation may fall quicker than expected but should not get too far ahead of the Fed, argued Austrian policymaker Robert Holzmann. Chief economist Phillip Lane considered: “Even if the near term inflation outlook is somewhat bumpy, the projected convergence of inflation to the target in 2025 will be underpinned”. Bundesbank President Joachim Nagel fully backed a June rate cut by the ECB. “If prices and the economy develop as expected, I would support a cut in key interest rates in June”.


The situation facing the MPC is not quite as clear cut. On the one hand the economy remained weak in the spring, on the other hand business surveys have become a little more positive. Optimism among the Chief Financial Officers of the UK’s largest businesses rose for the third consecutive quarter. Yes, core CPI inflation remains higher than desired, but energy price cuts will help bring down the annual rate of inflation in April, yet oil prices have also been rising. On the one hand, the claimant count measure of unemployment edged up again in March, but wages and salaries are still growing almost 5% from a year ago, whilst a survey by the Bank showed that expected future growth in wages is moderating noticeably.

The differences of view can be seen across the MPC. Megan Greene warned that the UK faced a heightened risk of persistent inflation and said that “rate cuts in the UK should still be a way off. The numbers that we’re seeing in terms of wage growth and services inflation just aren’t consistent with a sustainable 2% inflation target”. Conversely, some of her colleagues appear to be drifting towards rate cuts. Dave Ramsden has noted that inflation could potentially fall below the Bank’s recent forecasts, whilst Huw Pill considered that the most recent economic news brought a first rate cut closer. The next MPC decision might not be unanimous at all.

The pull of the US Treasury market, the world’s largest, is obvious, as global bond yields have moved higher. Indeed, the US 2 year bond yield touched 5% last week for the first time since last autumn. Worryingly, the money markets are pricing in a 20% probability that the next US interest rate move could be a hike rather than a cut! However, there are growing signs that the fundamentals affecting bond markets are diverging across the Atlantic and the next few months could see rather more fluidity between UK, European and US yields.

Bond yields at the time of writing

10 year %         Monthly move

USA                              4.66                             +0.47%

UK                                4.32                             +0.40%

Germany                      2.58                             +0.29%

Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.



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