Franklin Templeton Thoughts: ECB in little rush to cut rates

The European Central Bank left interest rates unchanged, without conveying any urgency to start cutting rates in the next few months. David Zahn, Franklin Templeton Fixed Income’s Head of European Fixed Income, weighs in on the implications for investors—and why lengthening duration may make sense.

The European Central Bank’s (ECB’s) January meeting seemed to mark a transition from the prior hiking cycle to cutting rates, but the central bank is not in any rush to do so. I think that was pretty clear. The Governing Council said it is “determined to ensure that inflation returns to its 2% medium-term target in a timely manner” and would remain “data-dependent.”

It seems most likely that June or July would be the preferred time to start cutting rates, as the ECB will want to ensure inflation is low and the economy doesn’t start to accelerate too much, which  might push off the timing.

Markets in Europe have priced in 125 to 150 basis points (bps) of rate cuts this year, but I think that’s overzealous. I think 75 or 100 bps seems more likely. In my view, there is no reason to cut rates too dramatically, and the ECB can be more methodical and can review the data before making decisions.

I don’t see a March rate hike in the cards, but the market is still pricing in that possibility. Most of the fight against inflation is probably over—as long as there are no external factors that cause inflation to surge again, particularly food and energy. It’s now a matter of timing. The question is how long it will take to come down and how well-behaved wages are, which would give more scope to lower rates.

The three-month Euribor has priced in more rate cuts than I would anticipate, so the market will likely need to reprice slightly higher in yield. However, if you look farther out on the curve, whether the ECB cuts 75 bps or 100 bps this year, it isn’t going to make a huge difference. It is the very front end of the yield curve that will see a greater impact.

I would like to note that there is a lot of talk about the yield curve in Europe being inverted, but this is sort of a misnomer. It’s the German yield curve from two-year to 10-year and two-year to 30-year that is inverted, but France and Spain have good upward-sloping yield curves. So, the risk-free rates are slightly inverted probably for other reasons, but the general rate structure in Europe is upward sloping and doesn’t create much of a problem, in my view.

Locking in yield

Given rate cuts are likely ahead, I think we will see investors move to lock in yield for the next several years and move into longer-duration assets. In general, we should see many investors moving out of short-dated instruments. If they are in cash, they will probably move into short- duration investments, and if in short-duration, into longer-duration investments.

Looking at the impact on green bonds in particular,  most are longer-dated when compared to conventional bonds. Most green bond indexes are about a year longer than similar conventional bond indexes. Green bonds had underperformed conventional bonds during the rate-hiking cycle, and I think they have scope to outperform considerably during the rate cutting cycle. The ECB will also likely be looking at greening its balance sheet, and there is desire for more robust infrastructure to generate power within home country borders. So, I see more green energy being built in Europe and more demand in that space from an investor standpoint.

In sum, I think the ECB has set up the bond market to have a decent year in 2024. It won’t be a straight line; there will be volatility as markets get accustomed to the change in the cycle. In addition, there are a number of elections across the globe this year, which could bring some short-term political noise. But volatility creates opportunity. We embrace volatility and manage accordingly. Currently, we are more focused on the core countries with better fiscal dynamics and that are more liquid—Germany, Austria, Belgium, as well as Spain.


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Mastering the Art of Saving: Ten Key Rules for Financial Success

Saving money is a foundational skill that can pave the way for financial stability and security. Whether you’re striving to build an emergency fund, save for a dream vacation, or plan for retirement, adopting the right saving habits is crucial. Here are ten essential rules to help you navigate the journey of saving and achieve your financial goals.

Set Clear Goals

Establishing specific and achievable savings goals is the first step in any successful savings plan. Whether it’s saving a certain percentage of your income each month, setting aside a fixed amount for a specific purchase, or building an emergency fund, defining clear objectives helps you stay focused and motivated.

Create a Budget and Stick to It

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Automate Savings

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Prioritise Debt Repayment

Prioritise paying off high-interest debts, such as credit card balances and personal loans, to avoid unnecessary interest payments that can drain your financial resources. Focus on creating a debt repayment plan that allows you to allocate more funds toward savings once your debts are under control.

Cut Unnecessary Expenses

Evaluate your spending habits and identify areas where you can cut back without significantly impacting your quality of life. This might involve reducing dining out, entertainment expenses, or subscription services. Small, conscious changes can add up significantly over time.

Build an Emergency Fund

Prepare for unexpected financial challenges by building an emergency fund that covers at least three to six months’ worth of living expenses. This fund acts as a safety net during unforeseen circumstances, such as job loss or medical emergencies, preventing you from relying on high-interest debt or depleting your long-term savings.

Invest Wisely

Explore various investment options, such as stocks, bonds, mutual funds, or real estate, that align with your financial goals and risk tolerance. Diversify your investment portfolio to mitigate risks and maximize potential returns over the long term.

Educate Yourself Financially

Stay informed about personal finance management, investment strategies, and market trends. Attend financial literacy workshops, read reputable financial publications, and seek advice from financial advisors to make informed decisions about your savings and investments.

Monitor and Adjust

Review your savings plan periodically to ensure you’re on track to meet your goals. Adjust your strategies as needed to accommodate changes in income, expenses, or financial priorities.

Stay Committed and Patient

Saving money is a long-term commitment that requires patience and discipline. Understand that building substantial savings takes time and perseverance. Stay focused on your goals and remain dedicated to your financial plan, even during challenging times.

By following these fundamental rules, you can establish a strong financial foundation and pave the way for a secure and prosperous future. Remember, every small step you take today contributes to a more stable and fulfilling financial tomorrow.

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