Bunds Hold Lower as Euro-Area Wages Rise 3.6% in Q1

Key Takeaway

• ECB is expected to cut rates in June, with wage growth data showing mixed signals; French wages fell to 3.6% in Q1.
• Euro faces downward pressure amid strong global commodities and potential dovish ECB rate cut; EUR/USD struggles below 1.09.
• Rising commodity prices, led by copper, challenge expectations for prolonged central-bank easing and could reignite stagflation concerns.

ECB Rate Cut Expectations

The European Central Bank (ECB) is widely anticipated to implement a rate cut in June, with market expectations nearing 100%. This sentiment is bolstered by recent data, including the ECB’s indicator of negotiated wage rates, which picked up to 4.7% in the first quarter from 4.5%, contrary to most economists' expectations of a drop or stable reading. Despite this increase, the ECB has indicated that wage pressures are expected to decelerate in 2024. Bloomberg Intelligence Rates Strategist Huw Worthington commented, "More timely figures from the ECB indeed hint that may be with us already." The number of anticipated rate cuts in 2024 has decreased from nearly seven at the start of the year to less than three.

Fresh data from the French labor office shows a decline in hourly wage growth, with first-quarter growth falling to 3.6% from 4.4% in the previous quarter and down from a peak of 5.4% a year ago. Worthington highlighted that "the official French data appear to be a good fit with Indeed’s wage tracker, which points to a further fall, to 2.3% growth, in 2Q -- within touching distance of the ECB’s comfort zone." This data could further influence the pace of rate cuts and potentially lower yields.

Euro Faces Downward Pressure

The Euro (EUR/USD) is experiencing downward pressure due to strong global commodities and the potential for a dovish ECB rate cut. The EUR/USD has struggled to break above the 1.09 level, and option traders may push the euro lower if the US dollar strengthens. A series of option strikes expiring from 1.0875 down to 1.0850 could see increased activity.

The ECB has also flagged risks from basis trades in Europe’s bond market, noting that offshore hedge funds hold over half of euro-area government bond futures. Despite this, the ECB downplayed the potential threat, stating that the strategy is conducted on a smaller scale in Europe compared to the US. However, ECB analysts warned that other hedge fund investment strategies, such as leveraged directional trades, could pose greater risks. "Leveraged trades are associated with higher financial stability risks than basis trades," ECB analysts wrote, adding that "spillovers to the euro area government bond market could be amplified, should these entities face liquidity strains in the US Treasury market."

Commodity Strength and Inflation

Copper's record surge highlights the broader strength in global commodities, which has significant implications for inflation and bond yields. The fundamentals have long supported an upside bias for metals, and the current speculative overstretch has only added to this momentum. This strength in commodities argues against sustained declines in global yields, as investors may be overestimating the potential for prolonged central-bank easing.

The broad rebound in goods prices undermines the case for a sustained global economic slowdown, which many bond traders have been anticipating due to high benchmark interest rates. Even if economic data starts to signal weakness, higher commodity prices could reignite stagflation concerns. Rising commodity prices have the potential to end the goods-price disinflation that helped bring down annual CPI gains in 2023.

Copper, in particular, plays a crucial role in the broader economy and is essential for the green transition. Efforts to reduce carbon emissions make it unlikely that raw material prices will see sustained decreases, except perhaps for fossil fuels. However, energy prices remain subject to OPEC+'s resolve to avoid severe declines and are also vulnerable to geopolitical risks in the Middle East, which can affect global goods trade.