KBC Sunrise Market Commentary 06/03/2025 via Trader Talent

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Market Commentary

Markets

•          German chancellor-to-be Merz’s fiscal whatever it takes triggered the biggest one-day move in the German 10-yr yield (+29.8 bps) since the reunification in 1990. It tells you something about both the importance of Germany letting go of its longtime devotion to the Schwarz Null and about how forceful they turn the ship in the other direction with a blank cheque for defense spending, a €500bn infrastructure fund and looser debt rules on a state level. German yields on a daily basis rose by 21.6 bps (2-yr) to 30.2 bps (5-yr) with the belly of the curve underperforming the wings. From a technical point of view, the German 10-yr yield took out both the previous 2025 top (2.65%) and the 2024 top (2.71%) with the 2023 top at 3.03% being the next target. The German 10y ASW spread hit a positive 15 bps with more widening (Bund underperformance) to come. The German 30-yr yield (3.08%) moved back above 3%. Apart from a brief spell in Q3 2022, this last happened back in 2011. We stick to the view that yesterday’s move in the Bund market wasn’t a one-off repositioning. The move at the front end of the European curves shows anticipation of the overflow from a looser fiscal policy (pro-growth, inflationary) to a more restrictive monetary policy, given that inflation is still stuck above the ECB’s 2% inflation target. We expect the ECB to lower its deposit rate by another 25 bps today, to 2.5%, while dropping the statement reference that those settings are considered “restrictive” policy. We don’t expect a lot of changes to the GDP & CPI outlook. At the press conference, we think that ECB Lagarde will incorporate the views of the hawkish wing inside the ECB calling for a pause in the current cutting cycle at the April policy meeting, our preferred scenario. Doing so would cause more repositioning in EUR money markets. The expected bottom in the ECB policy rate is currently back around 2%, coming from lower levels at the start of the week. We expect this week’s events to eventually raise it further towards 2.25%. European fiscal events this week served as a catalyst to propel the euro against as US-recession vulnerable USD. EUR/USD started the week at 1.0372 and closed yesterday at 1.0789, rocketing through 1.0533/51 resistance, to currently already test 1.0804 (62% retracement on Sep24-Feb25 decline). We position for a full retracement (1.1214) with a “hawkish ECB cut” likely accompanied by a more dovish tone by Fed chair Powell if he discusses the economic outlook tomorrow evening (payrolls also due with downside risks). Apart from the ECB meeting, there’s the EU Council on defense today which will specify the amounts Europe pledges to Re-Arm and to support Ukraine, but also the way they want to raise them. Expect more muscle flexing here. On the US side, weekly jobless claims and a Fed Waller speech could add to negative US vibes. The White House exempting car makers for tariffs on Mexico and Canada for one month is likely to be insufficient to change that US sentiment. More carveouts could be coming for certain agricultural products. It highlights that the US administration is walking a tightrope between getting what it wants through tariffs and the negative boomerang effect on the US economy.
 

News & Views

•          Portugal could have its third early election in less than four years in May. The country’s president put that timing forward yesterday in anticipation of a confidence vote next Wednesday. As things stand now, current prime minister Montenegro’s center-right minority government does not have enough support to survive the motion. The premier is haunted by and failed to quell speculation about potential conflicts of interest related to a company owned by his family. Some opposition parties have tabled a censure motion as recently as February. The biggest of them, the Socialist Party, helped the ruling AD (Democratic Alliance) coalition to defeat it. This time around, though, the socialists have already said they would vote against the government. The AD (30.4%) has 2.4 ppt lead over the socialists in recent polls. The far-right Chega party is third with 18%.

•          The UK’s Institute for Fiscal Studies, a leading think tank, said chancellor Reeves may soon have to choose which promise she’ll have to break and either raise taxes or return to austerity. The UK presents an update to the budget in its spring forecast on March 26. Since outlining the first Labour budget last October, however, borrowing costs rose sharply (including yesterday’s 15 bps) while the economic outlook deteriorated. This will be reflected in the budget watchdog’s (OBR) new forecasts and will all but certain wipe out the £10bn in fiscal headroom Reeves had projected in order to still comply with the self-imposed budget rules. One of these rules imply that day-to-day spending must be met by revenues.
 

Graphs

German 10-y Yield

The ECB is nearing a fine-tuning phase where back-to-back reductions are over. A rate cut in March (to 2.5%) may be complemented by removing the label “restrictive” on its policy stance as the debate on the neutral interest rate kicks off. For the long end of the curve, upward yield pressure stems from a massive defense investment wave that’s on the way. A test of the 2025 & 2024 tops might be in the cards.

US 10y yield

After three consecutive cuts, the Fed installed a pause in January which we expect to last at least through June. The Fed wants to see “serial readings” suggesting inflation is progressing towards target. A pause simultaneously offers time to a clearer view on president Trump’s policies. The prolonged Fed rates status quo provides a solid bottom beneath front-end US yields. The long end is more vulnerable on how the explosive policy mix could backfire to the US economy as well.

 

Calendar & table

Contacts