Investment Viewpoint: how did markets react to the ECB rate cut?

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Markets and macro insights with Bernard Swords, Chief Investment Officer

Last week, the ECB cut interest rates for the first time in five years – how did fixed income markets react? 

• It is important to note that central bank interest rates tend to fall (and rise) in cycles – and the first change in direction is therefore always a milestone event. History tells us that when rate cuts begin, they tend to exceed the magnitude of cuts expected and priced in by markets. 
• However, last week market interest rates actually rose slightly after the ECB cut interest rates. This was a very tentative and nervous start to the cutting cycle by the ECB.
• The rate cut occurred against a backdrop of revisions higher to ECB inflation and growth forecasts and amidst some nervous chatter from various ECB officials urging caution regarding future expectations.
• It could be argued that Friday’s employment data from the US was more important than the ECB rate cut. The predominant reason why rates move in cycles is that unemployment rates tend to trend once they change direction. Interest rates are then forced to adjust to push back against the extremes of the employment cycle.
• Unemployment rates have turned, and history suggests that it would be rare for them to turn back down again anytime soon. Confirmation from employment data in coming months could go a long way towards persuading or dissuading market participants that the ECB cut is more than a false start. The tick up to 4% in the US unemployment rate reported on Friday is a step towards that confirmation, notwithstanding the strength seen in the headline hiring numbers.
• Markets now expect rates to be about a percent lower at the end of 2025 than they are today. At the start of 2024, they had priced end-2025 rates a further full percentage point lower than they do today.
• This gives some indication of the scope for progress once the cycle begins in earnest, but progress will probably require further reassurance from inflation and economic supply-side data.

It was another strong week for equities – what drove this and what were the key data releases? 

• Equity markets took heart from the move in the bond markets; world equities rose over 1% last week and hit a new all-time high. 
• The IT sector led the equity move with Nvidia continuing its charge upwards. But there were also healthy moves from the sectors that can produce reliable profit growth including Communication Services; Healthcare and Consumer Staples. Conversely, cyclical sectors were the weakest last week. 
• There is nervousness about the level of economic growth in the second half of the year. There will be growth, but it will not be very strong – a sentiment that we believe will remain with us. 
• Indeed, this theme fed through last week’s data releases. Growth data indicated some softening in the global economy but no material weakness. 
• Euro area retail sales for April disappointed, with the level of sales falling 0.5% month-on-month. The lack of momentum in retail sales is surprising given the low level of unemployment and the growth again in real incomes. The only solace is that broader consumption has been stronger than retail sales. 
• In the US, the main business surveys (the ISMs) for May gave conflicting signals: the non-manufacturing survey was strong jumping 4.4 points to 53.8 – its highest level in nearly a year, while the manufacturing survey dropped to 48.7. The non-Farm Payrolls release was strong with the number of jobs created well ahead of expectations. However, a slight rise in the unemployment rate eased the inflationary fears of the strong number.
• Elsewhere, the Caixin PMI surveys were released in China – and the manufacturing index hit its highest level since June 2022. 

The week ahead: what to watch out for

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