JP Morgan has adjusted its prediction for the European Central Bank’s next rate cut, moving it from September to October. The bank keeps its terminal rate projection at 1.75%.
While many analysts expected a September cut, there is a difference of opinion on the terminal rate. Institutions such as Deutsche, Citi, Barclays, and Nomura projected a lower terminal rate of 1.50%.
Convergence in Forecasts
JP Morgan’s forecast agrees with that of Commerzbank, Goldman Sachs, Societe Generale, UBS, and Danske, who also estimate a terminal rate of 1.75%.
We see the revised forecast from JP Morgan as a signal that the path to lower rates may be slower than anticipated. This shift from a September to an October cut suggests near-term borrowing costs will not fall as quickly as the market had priced in. This adjustment in timing is the critical new piece of information for our strategy.
This view is supported by recent data showing Eurozone inflation unexpectedly rose to 2.6% in May, up from 2.4% in April. Furthermore, negotiated wage growth climbed to a record 4.7% in the first quarter, a key metric that complicates the central bank’s mission to sustainably lower prices. These statistics give credibility to the idea of a policy pause after the initial June cut.
In response, we should consider adjusting our short-term interest rate positions to reflect a more cautious central bank. This could involve reducing exposure to trades that relied on a September move or unwinding bets on rapidly falling Euribor futures. The focus now shifts to the fourth quarter for the next significant policy action.
Uncertain Policy Outlook
Beyond the immediate timing, the divergence in terminal rate predictions between institutions like Deutsche and Goldman Sachs highlights significant long-term uncertainty. Whether rates bottom out at 1.75% or a lower 1.50% creates a wide range of possible outcomes for the yield curve over the next two years. We must now position for this lack of consensus on the policy end-point.
Historically, the European Central Bank has acted with extreme caution, often preferring to pause and assess new data rather than commit to a rapid sequence of cuts. We saw similar data-dependent pauses during the easing cycle that followed the sovereign debt crisis, where initial market expectations for cuts were often pushed back. This historical precedent suggests a delay is a very plausible scenario.
This environment could make options strategies on interest rate futures particularly attractive, as they allow us to profit from increased volatility without betting on a single direction. We might also look at yield curve steepener trades, which would benefit if long-term rates remain relatively high while the market debates the ultimate destination of this cutting cycle.
