Just a single day after the European Central Bank's first interest rate increase in three years, some of the world's largest banks and asset management firms have already begun betting that it will reverse this move.
Institutions such as J.P. Morgan Asset Management, UBS Group, and RBC BlueBay Asset Management believe that the swap market is pricing in too many ECB rate hikes over the next year and underestimates the risk that policy tightening will push the eurozone economy into a downturn. They state that this discrepancy, along with the potential for the ECB to ultimately pivot, is creating opportunities to buy short-term government bonds.
For instance, J.P. Morgan Asset Management is bullish on short-dated European government bonds. These bonds have been sold off due to bets on policy tightening, pushing the yield on two-year German government bonds near a two-year high. While swap pricing eased slightly on Friday as oil prices fell, it still anticipates the ECB will raise rates twice more in the coming year, with rates then remaining stable until the end of 2027.
"The more they hike this year, the more likely they are to have to cut in 2027," said Hugh Gimber, a global strategist at J.P. Morgan Asset Management.
UBS strategist Reinout De Bock is betting the ECB will cut rates at least once between June 2027 and June 2028, positioning for this outcome by selling three-month Euribor futures expiring in June 2027 and buying equivalent contracts expiring in June 2028. The futures market currently sees less than a 50% chance of the ECB easing policy during this period.
The ECB's statement on Thursday did acknowledge growing growth concerns, lowering its economic expansion forecasts for 2026 and 2027. This meeting followed a significant revision to first-quarter data, showing the eurozone economy contracted at the start of this year.
Konstantin Veit of Pimco Europe GmbH told media on Friday that the growth forecasts appear overly optimistic, adding that he was "a bit surprised there wasn't more discussion around the growth outlook."
However, policymakers are currently maintaining a hawkish stance. Some have hinted that another rate hike could come as soon as July, citing the war's inflationary impacts as too significant to ignore. This stance reminds some observers of 2008 and 2011, when the ECB rushed to hike rates in response to rising inflation, only to pivot within months as growth deteriorated.
Mark Dowding, Chief Investment Officer at RBC BlueBay, expects that any rate hikes will be reversed next year as weakening economic activity helps bring inflation back to target.
"On this basis, we remain comfortable with eurozone short-dated yields and continue to expect German Bunds to outperform relative to US Treasuries," he told clients.
Comments