EUR-US swap rate spread to widen on Fed repricing

Two-year yields in the US have come back from their lows last week, the pricing of near-term Fed hikes remain subdued. A full 25bp rate hike is not priced until the January FOMC meeting next year and the probability placed on a hike in September is only around 30%. 

Danske Bank states, "Markets are currently placing a 65% probability of a first hike this year, which stands in contrast to the message from key FOMC members that a first hike is likely to come this year. The upcoming data is likely to triggered an adjustment in this pricing and continue to look for a first rate hike in September, although the risks are that this could be postponed to October or possibly December if financial conditions tighten or data prove less solid than expected."

Looking ahead to coming years, the current pricing  suggests an extremely slow tightening cycle with three hikes in 2016 and 2017 and only two in 2018. Therefore, Danske Bank expects a faster pace of tightening based on their projected path for the unemployment rate and wage inflation.

According to Danske Bank, "We expect the short end of the EUR swap curve to continue to be broadly shielded from rising US rates in coming months, as has been the case over the past year. Further, the recent decline in commodity prices further supporting low rates in the euro area, as a result, a significant euro-US spread widening is anticipated."