• European stocks markets lost up to 0.75% today. They managed to overcome an initial downleg, but eventual grinded lower on the back of a stronger euro and higher European rates. US stock markets opened nearly unchanged with Nasdaq again underperforming (-0.5%, correction tech rally).
• German bunds dropped and the euro shot higher following comments from ECB president Draghi that the euro area economic recovery remained on track, with signs of resurgent reflationary pressures (as opposed to the deflationary pressures previously). Still, Draghi did stress that caution in normalising monetary policy was warranted
• The BoE’s Financial Stability Report set out plans to increase capital requirements for UK lenders to tackle risks posed by the recent rapid growth in consumer credit and prepare for the uncertain outcome of Brexit talks. Additionally, next month the BoE will publish new guidelines for consumer lending to ensure risks are managed.
• The IMF has cut US growth forecasts to 2.1% for 2017 and 2018 (previously 2.3% and 2.5%), calling the Trump budget proposal forecasts unrealistic. It suggested the US to stay open to trade and to skilled based immigration. It also stressed the importance of the financial regulation and of an independent Fed to continue raising interest rates.
• US eco data surprised on the upside of forecasts. Consumer confidence increased from 117.6 to 118.9 while consensus expected a decline to 116. The "expectations" component disappointed though. The Richmond manufacturing Fed index improved from 1 to 7 in June (vs 5 expected).
• Italy’s consumer and manufacturing confidence surprised to the upside and stayed at elevated levels, boding well for the Q2 hard data to come.

Rates

Sharp correction lower of core bonds on Draghi

Just when traders were at risk of falling asleep after days of directionless trading, ECB president Draghi surprised them by explaining how the ECB could gradually unwind its non-conventional stimulus measures. It was clearly a turnaround of the ECB president, even if he remained very cautious and suggested that policy changes should be very gradually and depending on improving dynamics in the economy. "As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments — not in order to tighten the policy stance, but to keep it broadly unchanged." While Mario Draghi repeated that the governing council needs to be patient in letting inflation pressures build, his remarks should be considered as an early signal that policy will be adapted with a formal announcement of tapering likely at the September meeting, if the economy and inflation evolve as expected. He sounded also rather at ease with the recent low inflation readings which he attributed to energy effects and which don’t ask for an immediate ECB reaction. "Our analysis suggests that the drivers of low oil prices at present are mainly supply factors, which a central bank can typically look through. And even if supply factors affect the path of inflation for some time, with inflation expectations secure, they should not ultimately affect the inflation trend". Draghi added that deflation is off the table and reflationary forces are working their way through the economy.

The Bund turned south and continued its march lower, gradually but surely. The euro gained more ground, equities fell, while US Treasuries followed Bunds. The German yield curve increased by 4.5 (2-yr) to 8 bps (5-yr). US yields rose 3.5 to 4.4 bps the belly slightly underperforming. The underperformance of the 5-yr clearly suggests the significance for the monetary policy outlook. On the intra-EMU bond market, yield spreads versus Germany were little changed.

Currencies

Draghi propels EUR/USD close to the 1.13 resistance

Modestly hawkish comments from ECB Draghi drove trading in the major FX cross rates today. EUR/USD started a protracted intraday uptrend and trades currently in the high 1.12 area. The 1.13 resistance is within reach. USD/JPY dropped temporary lower as sentiment turned risk-off. However, the pair returned to the high 112 area, supported by a rise in core bonds yields.

Asian equities traded mixed this morning. USD/JPY held near the recent highs hovering in the high 111 area. However a test of the 112.13 resistance didn’t occur. EUR/USD settled in the 1.11 area. The recent sideways trading persisted.

European equities opened in a cautious risk off modus. Mid-morning, the headlines of a speech of ECB’s Draghi at the ECB forum in Portugal triggered volatility across markets. The ECB president repeated that the EMU economy still needs ample monetary stimulation. However, he also mentioned that deflationary forces in the economy were replaced by reflationary ones. He also indicated that very gradual changes to the ECB stimulation might occur. EUR/USD moved to the 1.13 area and USD/JPY to 112, even as European equities were left with decent losses.

There was no new drivers to guide trading at the start of the US session. Traders keep a cautious wait-and-see modus ahead of Fed Yellen’s speech later today.

UK government deal no big help for sterling

Two factors dominated sterling trading today: the comments from ECB president Draghi at the ECB forum in Sintra and the BoE’s Financial stability report. The Draghi comments propelled the euro across the board. EUR/GBP jumped to the 0.8820 area . However, there were also modest positive spill-over effects on cable. The pair trended higher in the 1.27 big figure. In the financial stability report, the BOE showed some discomfort with easing credit standards UK banks are applying for consumer credit. The bank increased the cyclical capital buffer from June 2018 to address this issue. These measures can be considered as some kind of monetary tightening. In the end it might make a rate high (slightly) less probable. As such it can also be considered sterling negative. Especially EUR/GBP remained well bid after the publication of the financial stability report. EUR/GBP is trading in the 0.8845 area. 0.8854/66 resistance is within reach. The impact on cable was far less obvious as the pair mostly followed the EUR/USD rebound. The pair trades currently in the 1.2770/80 area.