Market Analysis

Trades wager that the ECB's floodgates for rate cuts are open

Amos Simanungkalit · 18 Oct25K Views

Traders are increasingly betting on rapid European Central Bank (ECB) rate cuts after the bank announced its first consecutive rate reduction in 13 years. This move, prompted by a deteriorating economic outlook and signs of waning inflation pressures, saw the ECB cut its deposit rate by 25 basis points (bps) to 3.25%, following a similar action in September. This marks the first time the ECB has made back-to-back cuts since 2011.

While ECB policymakers emphasized that they are not committed to a specific rate trajectory and will maintain a restrictive monetary policy until inflation is fully controlled, there was little resistance from ECB President Christine Lagarde against the market's expectations. This led traders to increase their bets on future rate cuts, further weakening the euro.

Lagarde's statements reflected the ECB's dependence on data, according to Seema Shah, chief global strategist at Principal Asset Management. Shah noted the urgency for the ECB to implement consecutive rate cuts in light of economic weakness across the eurozone.

Sources informed Reuters that ECB governors anticipate a rate cut in December unless there is a significant economic turnaround. Traders are currently pricing in approximately 29 bps of cuts for the December meeting, having previously fully anticipated a 25 bps reduction. This implies that the market is factoring in over a 15% chance of a 50 bps cut.

Marchel Alexandrovich, an economist at Saltmarsh Economics, commented that markets are now speculating whether the next move will be 25 bps or 50 bps. Following that, there is a strong expectation of continued rate cuts through next June.

As a result, Germany’s two-year bond yield reached its lowest point since October 4, and eurozone stocks maintained their gains. However, the euro fell to $1.0811, its lowest level since early August.

Euro Risks

With the recent rate cut, traders anticipate the ECB will implement around 160 bps of rate cuts by the end of 2025, compared to 145 bps from the U.S. Federal Reserve and just over 135 bps from the Bank of England. The anticipation that Thursday's decision signals the beginning of a series of rate cuts has boosted eurozone government bonds, which, although underperforming U.S. Treasuries this year, have surpassed them in October.

Since the start of the month, eurozone government bonds have returned 0.1%, whereas Treasuries have resulted in a 1.2% loss for investors as the yield premium that Treasuries offer over German bonds has widened significantly. Despite this, the euro, which has faced considerable pressure this month, has declined approximately 3% since late September, when unexpected contractions in eurozone business activity heightened expectations for the rate cut.

This development coincided with traders pulling back from predictions of a significant Fed rate cut in November, thereby strengthening the dollar. Analysts believe that uncertainties surrounding the November 5 U.S. presidential election and the possibility of a Donald Trump victory pose significant risks for the euro. Trump's proposals for broad tariffs of 10% to 20% on nearly all imports could adversely affect the eurozone economy, a concern Lagarde highlighted on Thursday.

While such tariffs might initially be inflationary, they could ultimately undermine investment prospects and economic sentiment, leading to further disinflation and additional easing by the ECB, as noted by Mariano Cena, senior European economist at Barclays. Matthew Landon, global market strategist at JPMorgan Private Bank, expects the euro to fluctuate between $1.07 and $1.11, but it could drop 3-4% lower if higher tariffs become likely following the election. He added that the euro appears particularly vulnerable and has become one of their favored shorts ahead of the U.S. election.

The outlook for the ECB and eurozone markets remains complicated by the performance of the U.S. economy, which has surprised traders multiple times this year. Stronger U.S. retail sales on Thursday diminished expectations for Fed rate cuts, adding to the euro's struggles. Danske Bank chief analyst Piet Christiansen pointed out that while the euro area lacks a strong growth driver, the U.S. serves as a global growth engine. Should robust U.S. job data continue through the end of the year, it could introduce upside risks for rates.