ECB Terminal Rate Pushes Higher As Officials Hammer Hawkish Message

Authored by Ven Ram, Bloomberg macro strategist,

The European Central Bank’s hawkish message from its policy review last week is still rippling through the markets, sending the markets’ assessment of terminal rates higher.

Interest-rate traders are factoring in a terminal rate north of 3.40%, marking an emphatic move from levels of around 2.90% being priced in around the time of the Dec. 15 meeting.

The ECB’s communication has switched tack from getting to the neutral rate to a restrictive rate, with President Christine Lagarde expressly mentioning that increases of 50 basis points would be par for the course “for a period of time.”

Vice President Luis de Guindos reinforced that message for good measure this week, underpinning the increase in terminal rates.

Source: Bloomberg

Just like the Federal Reserve that has said that its job won’t be done until its real funds rate gets to significantly positive levels, the ECB sees such a mission as the defining moment in its journey to quell inflation.

With the ECB’s own forecasts showing inflation likely to be around 6.3% in 2023 and at 3.4% in 2024, a restrictive rate would perforce take its deposit rate in the range of 3.50%-4% in this cycle.

That backdrop makes it hard to be constructive on euro-area bonds, and nowhere is this perhaps more telling than at the front end of the German curve.

Source: Bloomberg

Two-year German yields have surged more than 300 basis points this year, and from the looks of it, there may be more losses to come in the first half of 2023 as the ECB goes about its task.