The ECB is holding its hawkish line

The Bundesbank’s Joachim Nagel, one of the more prominent hawks of the European Central Bank, has been on the wires over the past few days pushing the known narrative that rates need to rise further and that the fight against inflation was more akin to a long distance run than a sprint.

The transmission of monetary policy seems to be working with the latest ECB bank interest statistics showing a strong pass-through. On the inflation front there are also some more encouraging disinflationary signs. The PPI dipped into negative territory yesterday coming in lower than expected and pointing to lessening pipeline pressure. The ECB’s own consumer survey also saw a further drop in inflation expectations. At the same time the macro backdrop is getting gloomier, with the final PMIs having been revised lower just this week.

Some will caution that the ECB models are not as reliable nowadays as before, so there has to be an increasing focus on current inflation dynamics. While falling price expectations of consumers are positive, they are usually closely correlated to what happens with current inflation. Some more dovish ECB members, such as Italy's Visco, have spoken out against the hawks' calls to err on the side of doing too much on rates. 

For now the market is still buying into the story that more hikes are needed and is now fully discounting two more rate hikes from the ECB by the end of the year. But there are also question marks, and these will only get larger with more disappointing data, as to how tenable that hawkish ECB position is. Markets are discounting the first rate cut by summer 2024, though not yet fully discounting three cuts from the peak in total by the end of 2024. 

The longer outlook is showing growing cracks. Its not just that the curve remains deeply inverted. Its also real rates for instance that have not really recovered from their 40bp slump in late May to late June. Hitting a low around zero, the 5y5y real ESTR OIS is still below 10bp. The flipside though is a 5y5y inflation forward still at 2.55%, and still on an unbroken, general upward trend since mid-2020. This is something the ECB will be watching more closely.

Today's events and market views

US data remains the main focus. At the start of the week the ISM manufacturing again painted a gloomy picture, but the ISM for the services sector out today represents the larger share of the economy. Here the consensus is to see a rebound from the dip to the 50 level, and we think this should help a great deal in getting 10Y UST yields to 4%.

Ahead of tomorrow's official US jobs report the ISM's employment sub component will also get more scrutiny – it had dipped below 50 last month, contrasting with the later strong payrolls number. Of course, the ADP estimate will also have some (limited) bearing on expectations tomorrow, while the initial jobless claims and JOLTs job openings data should allow a more contemporaneous sense of the current labour market situation in the US. So far it has been surpringly resilient.

The main data event in the eurozone are the retail sales numbers following Germany's factory orders this morning. The Bundesbank's Nagel has his fourth scheduled appearance this week.

Sovereign bond supply will come from France and Spain today. Being geared to the longer end of curves supply may have helped the curve bounce off the extreme lows in past sessions.