Something for Your Espresso: Who’s Playing Catch-Up – The Fed or the ECB?

Morning from Copenhagen and Happy Friday!
It was a nasty close in the U.S. session yesterday, largely due to a semi-hawkish ECB meeting. The ECB effectively took 50bp cuts off the table while ramping up quantitative tightening (QT). We were probably one of the few in town who dared to pay EUR front-end rates ahead of this meeting, but it paid off big time.
I am, however, a bit worried that the ECB is overdoing it with the QT scheme, especially as liquidity is already very tight in the Eurozone. Adding to the complexity, the market entered this meeting monster-long European fixed income (FI), which made for a brutal session, particularly in BTPs yesterday.
I believe the BTP market is now at risk of quickly reversing much of the gains it saw in November and December due to these positioning dynamics.
Breaking Down the Market Reaction
On the positioning front, EUR rates remain the softest relative to their global peers. Similar to the Bank of Canada, it feels like the ECB was somewhat compelled to deliver a “hawkish cut.” Why? I think it has to do with the growing divergence between what the Fed and BOE are pricing versus the ECB.
While many believe the Fed and BOE might be “too hawkish,” I tend to sit in the other camp, arguing the ECB is too dovish. It’s essentially the same trade, but I suspect the EURIBOR leg will unwind much faster than SOFR or SONIA as it “plays catch-up.”
Chart 1.a: Europe’s fixed income positioning is still very much stretched long.
As the Fed and ECB navigate different paths, markets wrestle with rate cuts, QT, and shifting inflation dynamics.
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