European Central Bank lowers interest rates ahead of anticipated Federal Reserve cut

Central banks worldwide are changing their policies, but not all at the same time. This puts more focus on when the U.S. Federal Reserve might lower rates.

According to the CME FedWatch Tool, it is very unlikely that the Fed will cut rates at its meeting next week, with a 0% chance of a cut this month. However, investors are hopeful for lower rates in 2024, expecting about a 50 basis point cut by the end of the year.

Global bond yields fluctuate amid policy shifts

Bond yields, which directly affect the borrowing costs for both consumers and companies, have dropped significantly in the past few weeks. This change became more apparent as global central banks signaled a shift in their policies. Currently, yields on 10-year U.S. Treasury notes stand at roughly 4.3%, the lowest they have been in two months, and down by 30 basis points since early May.

Lower interest rates usually help boost the economy because they make borrowing cheaper for everyone—from individuals to big businesses. On the other hand, higher rates tend to slow down economic growth and are often used to fight inflation and maintain the value of currencies.

The high returns from cash that people have enjoyed recently won't last long. Once central banks start easing their policies, those returns are expected to decline, says Solita Marcelli, UBS Global Wealth Management’s chief investment officer for the Americas.

Borrowing will become cheaper, and the big gains from money-market funds and government bonds seen in the past two years will dwindle. These funds and bonds are closely tied to the rates set by the federal government.

Germany’s benchmark 10-year bond yield increased by 6 basis points, reaching 2.557%. Meanwhile, the yield on Germany’s 2-year bond rose by 4 basis points to 3.025%. Italy’s 10-year bond yield climbed by 7 basis points to 3.88%, and Spain’s 10-year bond yield went up by 6 basis points to 3.29%.

As the ECB made its first rate cut since 2019, experts quickly pointed out the uncertainty about the future. The Governing Council stressed a data-driven and meeting-by-meeting strategy, making a follow-up cut in July unlikely due to limited European data before the next meeting. Gaël Fichan, head of fixed income at Bank Syz, described this decision as a hawkish cut.

Divergent interest rates will likely prompt various movements in stocks, currencies, and bonds shortly, analysts say. According to KPMG's chief economist Yael Selfin, the euro zone's economy is in a different situation compared to the US. While Europe struggles with the aftermath of a cost-of-living crisis impacting household incomes, the US sees strong domestic demand despite rising inflation and a relaxed fiscal policy.

Moreover, the Federal Reserve's tighter stance could further strain global financial conditions, as it may push European long-term bond yields up. This could necessitate more significant policy measures at the short end of the curve in Europe.

Gold surges as Central Banks hint at rate reduction

Gold prices, measured by XAU/USD, have climbed to a two-week peak of around $2,375 during the European trading hours, marking several days of steady gains. This increase is linked to the belief that major central banks will reduce interest rates to boost economic activity.

Market mood leans towards the Federal Reserve possibly cutting rates amidst hints of a slowing US economy. As a result, yields on US Treasury bonds are still low, which doesn't help the US Dollar much.

Geopolitical tensions make gold a popular safe bet. However, XAU/USD gains are limited as traders look forward to the US Nonfarm Payrolls report.

A break above $2,364 could spark a positive move, with barriers expected near $2,400 and $2,425. On the flip side, if it falls below $2,360, it might find support close to $2,340, reducing the potential for further losses. Additional drops might break the 50-day Simple Moving Average, possibly testing support at $2,280.