Markets
In the run-up to key events, moves on financial markets usually hold little information. It was no different yesterday ahead of today’s ECB policy meeting. German yields eased 1 or 2 bps. US Treasuries outperformed, seeing yields decline up to -5.7 bps at the front end in a steepening move. Recent dollar strength reversed with the trade-weighted DXY returning below the psychological 100 barrier. It also helped EUR/USD rebound from the 1.082 area to a close of 1.0888. Technical factors may have done their part too. The pair found key support provided by the 2022 low of 1.0806 and the upward sloping trendline connecting the lows of 2017, 2020 and 2022. Whether the euro has more room to run, is completely up to Lagarde and the ECB. The April meeting is without new forecasts but it could be an important one nonetheless. Back in March, the central bank accelerated the APP taper process. Net bond buying was scheduled to end in Q3 but with the optionality of resuming should the outlook worsen. The March Minutes revealed how some governors wanted the summer as a firm end-date, adding that the ECB risks falling behind the curve. Recent inflation data (7.5% y/y) suggest so by making the March inflation forecast already outdated. A much clearer anti-inflation signal from the ECB is needed. Its credibility is at stake: market inflation expectations for the eurozone (10y inflation swap) have risen sharply to about 3% in recent weeks, a series high. Barring the extremely volatile and illiquid 2008 crisis period, the difference with the US has never been lower (near zero). Pressure is also building from peers. Just yesterday, both the Reserve Bank of New Zealand and the Bank of Canada went from raising by a regular 25 bps pace to double that size. The Fed already regrets not having done so in March while again above-consensus CPI in the UK does not allow the Bank of England to dial back the normalization process. Last but not least: the euro. The common currency is suffering from high inflation (expectations) and the lack of clear willingness to fight it. A weak euro spurs price rises even further and thus risks getting trapped in a vicious circle. We believe the hawks at the committee have more than enough arguments to leave their mark on today’s meeting. Chances are APP’s Q3 optionality will be put to bed, but probably verbally (by Lagarde in the press conference) rather than formally (statement). Doing so gives the central bank leeway for a quicker start of the rate hike cycle, potentially in July. Markets would surely adjust accordingly, especially the euro. The first meaningful resistance in EUR/USD is located at 1.1186 but a close above 1.10 is already a nice plus ahead of the long weekend.
News Headlines
The Bank of Canada stepped up its tightening pace yesterday by lifting its policy rate by 50 bps, from 0.5% to 1%. Starting April 25, the BoC will also stop its reinvestment policy of maturing Government of Canada bonds, allowing the size of the balance sheet to decline over time. By the end of fiscal 2024, BoC bond holdings will be slimmed down by C$155bn to C$267bn. Canadian inflation (5.7% Y/Y) exceeds the central bank’s forecast and is driven by rising energy and food prices and supply disruptions, in combination with strong global and domestic demand. Inflation is now expected to average almost 6% in the H1 2022 and remain well above the control range throughout this year. It is then expected to return to the 2% target in 2024. The BoC points to an increasing risk that higher inflation expectations become entrenched. Interest rates will need to rise further and governor Macklem signaled preparedness to move more forcefully than +50 bps on rates if needed. The BoC also raised its estimate of a nominal neutral rate to the 2%-3% range, 25 bps higher than in the April 2021 assessment. The loonie performed well after the hawkish BoC meeting with USD/CAD dropping more than 1 big figure, from 1.2670 towards 1.2550.
