- European equities ignored hesitant stock market sentiment on WS yesterday and Asia this morning because of the leaked Trump Jr. emails. Main indices gain more than 1.25%. US stock markets open around 0.6% higher as Yellen’s warning on inflation puts an additional rate hike this year marginally in doubt.
- Janet Yellen has acknowledged the Fed is facing uncertainty as to when US inflation will finally pick up in response to the strengthening economy, even as she continued to chart out a course towards gradual rate rises and the unwinding of the central bank’s quantitative easing programme.
- British workers saw their pay fall further behind inflation in the three months to May even as the unemployment rate hit a new 42-year low (4.5%). Today’s data will have complicated the debate among Bank of England officials over the need for higher interest rates.
- France is at risk of being the only country in breach of the EMU’s budgetary rules this year. The EC recommended Athens leave the EMU’s "excessive deficit procedure" for countries whose budget deficit exceeds an upper limit of 3% of GDP. Greece is now ready to "turn the page on austerity and open a new chapter of growth".
- Output at the eurozone’s factories, mines and utilities rose at the fastest annual pace in more than five years in May (4% Y/Y), a fresh indication that the eurozone’s economic recovery picked up in the second quarter. On a monthly basis, industrial production increased by 1.3% (vs 1% M/M consensus).
- OPEC’s output rose by roughly 1.4% to 32.61 million barrels a day in June, compared with May, led mainly by production increases in Libya, Nigeria, Angola, Iraq and Saudi Arabia, according to OPEC’s closely watched monthly market report. Brent crude traded with a small downward bias today, heading towards $48/barrel.
- High and rising government debt levels are the biggest threat to countries’ financial stability as political support for austerity wanes, ratings agency Fitch has warned.
- US President Trump defended his eldest son as "innocent" following emails that showed Donald Trump Jr. welcomed Russian help against his father’s rival in the 2016 presidential election, deepening the controversy over purported Russian meddling.
- The Bank of Canada lifted its benchmark lending rate for the first time since 2010 (to 0.75%), reacting to rapid job growth and buoyant property prices, in the latest sign that global policymakers feel comfortable peeling away stimulus measures.
Rates
Subtle warning on inflation lifts US Treasuries
Global core bonds started on a decent footing. The leaked emails which related Trump’s eldest son to the Russian government offer an obvious explanation at first sight. However, the story is less straight forward taking into account the recovery of the US dollar and the outperformance of European stock markets. Around European noon, both the Bund and US Note returned to opening levels as investors seemed to throw the towel on the "Trump play". It proved to be premature as core bonds shot higher after the release of Fed chair Yellen’s written statement for US Congress. While her statement was nearly a copy from the June policy statement, investors focused on a modest warning on inflation. US Treasuries outperformed German Bunds. The eco calendar included only strong EMU production data, but markets ignored them.
At the time of writing, changes on the US yield curve range between -3.6 bps (2-yr) and -5.5 bps (5-yr). The German yield curve bull flattens with yields 1.2 bps (2-yr) to 3.6 bps (30-yr) lower. The underperformance of the 10-yr yield (+3.6 bps) is due to a benchmark change.
The German Finanzagentur held a €5B 10-yr Bund auction (0.5% Aug2027). Total bids amounted €5.66B, way above the €3.59B average at the previous 4 Bund auctions. The Bundesbank retained €0.99B of the amount on offer for secondary market operations, resulting in an official bid cover of 1.4 (real bid cover: 1.1). The auction tailed 2 cents. The auction yield (0.59%) was the highest since the end of 2015 and might partly explain above average demand. The Portuguese treasury tapped the on the run 10-yr and 30-yr OT’s (€0.69B 4.125% Apr2027 & €0.31B 4.1% Feb2045). The combined amount sold was the maximum of the €0.75-1B with an auction bid cover of 1.71. The US Treasury continues its refinancing operation tonight with a $20B 10-yr Note auction. Currently, the WI trades around 2.3%.
Currencies
Mixed dollar trading on Yellen’s testimony
The dollar started the session on a weak footing as markets pondered the potential fall-out from the Trump Jr. emails. During the day, focus turned to Yellen’s statement before US Congress. Yellen basically maintained the Fed’s assessment from June, but soft inflation needs close monitoring. The reaction of the dollar is mixed. USD/JPY remains under pressure. The pair dropped to the 113 area. EUR/USD reversed an initial topside test and is changing hands in the 1.1425 area.
Overnight, Asian equities traded mixed to slightly lower as investors pondered the potential impact of the Trump Jr. emails. The dollar in particular traded in the defensive. The BOJ kept interest rates low by additional bond purchases in the 3-5-yr sector. Even so, it didn’t prevent a further setback of USD/JPY. EUR/USD traded also with a positive bias, setting a new correction top in the 1.1489 area. Asian investors were cautious on the dollar ahead of Yellen’s testimony before US Congress.
European equities opened with remarkable resilience given the uncertainty in the US and considering the ongoing euro rally. However, there was again little consistency between markets. Core (European) yields initially declined and the rise in EUR/USD took a breather. EUR/USD returned to the mid 1.14 area. USD/JPY also stabilized in the 113.50, awaiting Fed’s Yellen testimony. The Bank of Canada’s policy decision was also a factor of (second tier) importance as it could be a pointer for global central bank policy normalisation. A rate rise would suggest that the likes of the ECB are also coming closer to a policy shift.
The prepared text of Yellen’s testimony before the House Committee basically maintained the message from the June policy statement. The economy is expected to continue to grow at a moderate pace. Risks to the economy are balanced. Inflation remains below target, but this is probably partially due to special factors. Even so, the issue deserves close monitoring. In a first reaction interest rate differentials narrowed further against the dollar. Especially USD/JPY declined further to the low 113 area (even as equities rebounded). EUR/USD tried a retest of the recent lows, but the rebound stalled in the 1.1480 area. Afterwards, some intraday profit taking kicked in. Profit taking on the recent sharp rally in EUR/JPY might have played a role, too. USD/JPY trades in the low 113 area. EUR/USD is changing in hands around 1.1420.
Sterling rebounds on good UK labour market data
Sterling suffered further losses yesterday as markets doubted the scenario of a BoE rate hike in the near future. EUR/GBP rebounded well north of the 0.89 barrier. The glass for sterling was again half full rather than half empty today. The May UK labour market report was solid. The unemployment rate dropped to the historically low level of 4.5% and job growth was stronger than expected. Weekly earnings rose modestly from 1.8% Y/Y to 2.0% Y/Y (1.9% Y/Y was expected). This leaves real wage growth negative given a May inflation reading of 2.9%. The jury is still out what this will mean for the August policy decision. Even so, the report was good enough to trigger some profit taking on sterling shorts. EUR/GBP returned below the 0.89 barrier. The pair trades currently in the 0.8870 area, reversing most of yesterday’s gain. Cable also rebounded, partially supported by underlying USD softness. The pair trades currently in the 1.2880 area.
