Sunset Market Commentary

Markets

Yesterday’s ECB assessment that rates being kept at current level ‘for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target’, understandably caused markets to conclude that the hiking cycle might be over. With markets looking forward by nature, the question on the timing of the first rate cut is looming on the horizon. This yesterday resulted in a mild decline in yields. However, even in a forward looking attitude, it is simply too early to play the U-turn in the euro interest rate cycle. Lagarde already said she couldn’t confirm that ECB rates had reached their peak. An FT article also suggested that ECB hawks still see the December meeting/projections as a new point of evaluation. If inflation or wage pressures stay too high a rate hike might still be discussed. ECB’s Vasle today indicated that the current rate level also opens more space to debate to discuss QT/an acceleration the reduction of the APP portfolio. This idea in theory supports the case for some curve steepening. This is what happened today. German yields rose between 4.5 bps (2-y) and 7.6 bps (30-y). This doesn’t look like a market that is already focused on the timing of a rate cut. After yesterday’s rise, US yield gains are lagging the rise in EMU. Still, US data confirmed the economic resilience. The Empire Manufacturing survey of the New York Fed unexpectedly returned into positive territory (1.9 from -19), with a sharp rebound in shipments and orders. Price indices also remained at elevated levels. Another report showed US import prices rising 0.5% M/M due to higher petroleum prices. Admittedly, these are not the most important data and they won’t change the Fed’s assessment at next week’s meeting. Even so, they are strong enough to keep bonds in the defensive with US yields rising between 1-3 bps across the curve. The US 10-y yield (4.32%) is only a whisker away from the cycle top at 4.34/4.36%. After finishing this report Consumer confidence of the University of Michigan (especially the inflation expectation measures) still has market moving potential. The EuroStoxx50 initially gained up to 1.0%  building on WS gains and a positive sentiment in Asian after some hopeful figures out of China. However, momentum dwindled as US traders joined (EuroStoxx50 currently +0.6%; S&P 500 even opened with a loss of 0.35%).

In FX, the dollar rally shifted into a lower gear, but there is no sign at all that any meaningful correction might be on the cards. EUR/USD stabilized in the 1.0635/1.067 area. The 1.0635 support is far from save. The DXY is holding well north of 105. (105.37). USD/JPY set a minor YTD top just below 148. Markets are looking out for a potential policy reaction (or the absence of it) as the BOJ meets next Friday.

News & Views

The Turkish central bank (CBRT) is making it more expensive for local banks to offer short-term deposit schemes to clients under the KKM program. KKM is an initiative introduced in late 2021 via which Turks can deposit their liras (TRY) on accounts that offer a certain interest rate. If TRY losses would surpass the interest received on the deposit, the government compensates for the difference. It dampened the incentive to swap ever depreciating liras for FX, including the dollar, and turned out to be instrumental in containing further losses for the currency. The downside, however, is that it is draining state finances. The CBRT now decided to lift the amount of money that banks must hold as reserve by raising the reserve requirement ratio from 15% to 25%. This will drain TRY liquidity from the market (as banks hold more reserves) but the move risks losing efficacy if consumers start swapping the liras that no longer can be deposited under KKM again. USD/TRY today marginally gains to 26.98, further erasing losses after the shocker interest rate hike by the CBRT end of August. USD/TRY back then briefly traded below 26.

In its quarterly survey, the Bank of England finds that public trust in the institution has fallen to the lowest level since conducting the questionnaire in 1999. 40% of the respondents think the central bank is doing a bad job, up from 24% in May. This compares to less than one in five being satisfied with the BoE. The survey also gauges consumers for their inflation expectations. Those for the year ahead rose from 3.5% to 3.6%, well above the 2% BoE target. Consumers see inflation two years ahead at 2.8%, up from 2.6% in the May survey. It’s bad news for the central bank. Threadneedle Street meets next week Thursday. Markets have rapidly pared tightening bets over the past few weeks amid weakening economic data. They do expect at least one (but less than two) more rate hike(s), but not necessarily at the September meeting (70% chance discounted).