Commerzbank economists highlight that markets now price a more proactive ECB stance, with €STR forwards discounting at least one 25 basis point hike by July and nearly two by year-end, even as growth risks rise. In contrast, Fed Funds and OIS curves have only pared rate-cut expectations, leaving 2-year UST yields trading above the effective Fed Funds rate and interest on reserve balances.

Market pricing of policy trajectories

"Market focus will be on the economic implications and the policy reaction functions with Fed, ECB, BoE and BoJ meetings lined up on Wednesday and Thursday, followed by the EU leaders' summit."

"The market is therefore anticipating a proactive, zero-tolerance ECB that is willing to sacrifice growth in order to defend its inflation credibility. €STR forwards are pricing in a full 25bp rate hike by July and almost two rate hikes by year-end. 2y Schatz yields have risen 45bp since the beginning of the war."

"The new situation will most likely lead to controversial discussions within the governing council, but we are not convinced that a majority in favour of a near-term rate hike will emerge. As such, the ECB is unlikely to commit to the direction of rates, but the staff projection scenarios should allow for tough words from Lagarde."

"The Fed faces similar challenges. 2y UST yields are now trading above the effective Fed Funds rate, and also for the first time since 2023 above the Fed's interest on reserve balances (IORB), even though Fed Funds and OIS forwards have only pared rate cut expectations and are not pricing in any rate hikes."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)