• Equities in the US and Europe both show gains between 0.25% and 1.0% as the tech correction has apparently run its course, at least for now.
• The May NIFB small business optimism Index was unchanged at a historical high of 104.5. It suggests businesses have kept their post-Trump optimism despite signs that introducing policies will be difficult. The most sub-components showed little variation too. Worth mentioning, the employment and the actual compensation sub-indices increased.
• Finland’s Sipila’s Center Party and Finance Minister Petteri Orpo’s National Coalition are now counting on keeping their coalition together after Foreign Minister Timo Soini and 19 loyalists formed a new legislative group and pledged support for the government.
• The German ZEW economic sentiment index was strong, but showed a mixed picture. While the current situation component rose to 88, near cycle peaks and exceeding expectations, the expectations sub-index unexpectedly dropped to 18.6 from 20.6, which was lower than expected. All in all, the release shows that the German economy is moving at full speed.
• Crude oil prices showed modest gains on Tuesday after a report showed that OPEC’s output climbed in May despite an production agreement to curb supply. Nigeria and Libya offset cuts of their peers. Brent fell to $48.26/barrel from $48.67/barrel.
• UK inflation exceeded expectations in May, pushing yields sharply higher. Headline CPI rose a higher than expected 0.3% M/M and 2.9% Y/Y, up from 0.5% M/M and 2.7% Y/Y in April. Producer prices for May were in line with expectations. The higher consumer price inflation is still linked with the depreciation of sterling. We don’t expect the BoE to act when they meet on Thursday, also given current political uncertainty; but we keep close eye on gilts.
• US producer prices were a tad above expectations, especially core ones. It should be welcomed by the FOMC, which is looking for some faster inflation. Indeed, headline PPI was up 2.4% Y/Y, down from 2.5% Y/Y in April, but above the expected 2.3% Y/Y. PPI excluding food and energy was up 0.3% M/M (0.1% M/M expected) and 2.1% Y/Y (up from 1.9% Y/Y previously).

Rates

Core bond yields and especially gilt yields higher

In a thinly traded session, talk about the outcome of the FOMC meeting, to be released tomorrow, dominated, even as the rise in US PPI didn’t go by completely unnoticed. Core bonds moved lower in early European trading, but moved by and large sideways afterwards, with US Treasuries dropping slightly after the PPI release. The eco data (see headlines), aside from a sluggish response on the PPI, were flatly ignored. UK gilts, on the contrary, sold off in a move that started after the inflation data release. We should also mention critical words from a Bundesbank governor and FM Schaeuble regarding the ECB monetary policy, as they pushed the short end of the German curve higher. They look forward to a speedy debate on and the gradual unwinding of the unconventional measures. At the same time, ECB Liikanen defended the dovish policy stance as he said the economic recovery was not sufficiently strong to raise inflation. A substantial degree of stimulus is needed, he echoed Mario Draghi’s words.

At the time of writing, the German yield curve shifted 2 (2-yr) to 2.6 bps (10-yr) higher with the 30-yr yield added slightly less (1.3 bps). The US yield curve shifts 0.8 bps (2-yr) to 1.4 bps (30-yr) higher. In the EMU bond market, the spread narrowing wave of past days continued with Greece, Portugal, Spain and Italy coming in 3-4 bps at the 10-yr tenor versus Germany.

German officials ask for a discussion on the ECB policy. Bundesbank Wuermeling said: "You don’t have to be a hawk to ask for an early discussion because the process of building up neutrality in monetary policy is very very long so you have to start it early to avoid turbulence". "We still have the foot on the accelerator, and you probably won’t be surprised to hear that the Bundesbank is advocating a discussion about this monetary stance". "To say that the interest rates won’t be lower is half the way of the U-turn". That corroborates with our analysis of the ECB meeting that the ECB took away half of its easing bias to be able to delay the discussion on the APP programme. German FM Schaeuble spoke in a similar sense: Low interest rates have distorted risk-taking: "We need to exit current monetary policy in a timely manner" and return to "more normal policy". "It’s not easy for the ECB, with all due respect"

The ECB is unlikely to include Greek bonds in its asset-purchase program for the foreseeable future, a person familiar with the matter said, as European creditors aren’t prepared to offer substantially easier repayment terms on bailout loans to improve the nation’s debt outlook. The euro area FMs will meet though on June 15 to discuss debt relief measures that might change the ECB viewpoint.

Currencies

Dollar stabilizes ahead of FOMC decision

Today, FX traders were in a wait-and-see modus ahead of tomorrow’s FOMC decision. USD/JPY gained a few ticks as global equities recovered from the tech correction and as core bond yields rose a few basis points. EUR/USD held a tight range close to and mostly just north of 1.12 as there was little news from the EMU to guide any directional move.

Overnight, Asian equities recouped part of the yesterday’s losses as the US driven tech correction eased. USD/JPY tried to regain the 110 barrier. EUR/USD lost a few ticks and dropped (temporarily) below 1.12.

There was no dominant story for FX trading. The EMU eco data were second tier and showed a mixed picture (e.g. German ZEW investor sentiment). European equities opened higher, but moved mostly sideways intraday. Core yields in the US and Europe rose a few basis points, with the interest rate differential narrowing slightly in favour of the euro. However, all this was not enough to inspire a real directional move. EUR/USD settled in a tight range in the low 1.12 area. USD/JPY tried to sustain north of 110.

The US NFIB small business confidence was in line with expectations. US PPI was marginally stronger than expected. The dollar gained a few ticks upon the release but this report again was too light to unlock the stalemate going into tomorrow’s FOMC decision. EUR/USD currently trades in the 1.1210 area. USD/JPY is changing hand at around 110.15.

Sterling rebounds slightly on higher UK inflation

Today, sterling selling eased. The political uncertainty remains high, but the battle for Theresa May’s political survival has apparently become less aggressive than it was over the previous days. Sterling gradually started a bottoming-out process. Mid-morning, the May UK inflation rate rose more than expected, from 2.7% to 2.9%. Core inflation was also above consensus at 2.6% Y/Y. Higher inflation might at some point lead to a difficult balancing act of for the BoE. After the release, UK bond yields rose about 6 bps. However, with growth and growth expectations declining and given the extreme degree of political and economic uncertainty, a BoE rate hike is highly unlikely in the near future. Still, sterling slightly regained ground after the inflation data, both against the euro and the dollar. EUR/USD dropped to the low 0.88 area. Cable rebounded north of 1.27. Even so, the rise of sterling was modest given the rise in UK yields. For now, we consider today’s intraday rebound as a technical correction on the recent setback rather than anything else.