Are Euro ESTR and SOFR Traders' Expectations Realistic?

AT A GLANCE

• In the United States, SOFR futures are pricing roughly 200 basis points of rate cuts in late 2023 and 2024

• Eurozone core inflation is at 5.2% and the ECB just raised its lending rate to 3%. That’s a 2.2% real rate of interest

There are lots of differences between Europe and the United States, but short-term interest rate traders see plenty of commonalities. On both sides of the Atlantic, traders see central banks initiating two more 25 basis point hikes, followed by a period of dramatic monetary easing. But are they suffering from a bout of unrealistic expectations?  

In the United States, SOFR futures are pricing roughly 200 basis points of rate cuts in late 2023 and 2024. It’s hard to say what the U.S. economy might look like later this year or next year, but for the moment, it remains white hot. The United States added nearly half a million jobs in January, and unemployment fell to a 53-year low. What’s more is that U.S. employers are still looking to hire 11 million people. 

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Labor markets in Europe are also much tighter than they were before, but what is especially curious about the pricing of Euro ESTR futures is that Eurozone core inflation is at 5.2% and the ECB just raised its lending rate to 3%. That’s a 2.2% real rate of interest. Will the ECB be able to bring down inflation with policy rates that are still negative in real terms? 

Unless we see softer jobs growth and inflation numbers, the idea of ECB and Fed rate cuts later this year and next year might be called into question.

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