Markets
On the absence of hard eco data, markets yesterday mainly continued recent trading patterns. No news still proved good news for core bonds, with both the US and the German yield curve bull flattening. Recent decline in US yields didn’t hamper investors’ appetite for the sale $38bln of 10-y US Treasuries which showed strong metrics. US yields declined up to 4.7 bp (30-y) but the real yield was little changed. German yields lost up to 2.0 bp (10-y). Equities initially held close to recent peak levels but US indices eventually fell prey to modest profit-taking. Initial dollar weakness was reversed later in the session. EUR/USD closed at 1.2180. DXY finished at 90.12.
Today, US May inflation and the ECB policy decision hopefully will give investors some clarity on the key topics they were counting down for of late. US monthly price rises are expected to slow to 0.5% M/M both for the core and the headline, but Y/Y price growth is expected to reach peak levels of 3.5% Y/Y and 4.7% Y/Y respectively. Last month, strong US inflation triggered a yield spike but since then the US 10-yield drifted south and is testing the 1.47/1.50% range bottom since March. This decline is mainly due to easing inflation expectations. Markets apparently embrace the idea that today’s inflation data will mark some kind of culmination point in the (US) inflation narrative. Even if so, the Fed tapering debate has to start anyway as the economy returns to normality. Bonds currently enjoy a strong momentum. Still, we don’t anticipate a protracted further decline in US yields from current levels. For this, we need probably unexpected slowdown inactivity. Quod non. On the ECB policy decision, recent comments from dovish ECB members made markets conclude that ECB will maintain ‘substantially higher’ PEPP bond-buying above the Q1 levels also in Q3. This remains a bit at odds with the EMU economy finally showing signs of a sustained recovery. Even if the ECB repeats its commitment to keep accommodative monetary conditions across the region, we see room for nuances with respect to Q3 PEPP buying. The bank won’t give a specific target level and seasonal factors (e.g. lower summer liquidity) might provide some flexibility to de facto slow purchases. This would also leave the ECB with some part of the envelope unused at the end of the program in March 2022 that can be used to smooth the overall tapering process. Our conclusion for EMU yields is similar as for the US: we assume a further decline of the German 10-y yield below the 0.20%/0.25% won’t be evident. The FX market EUR/USD recently developed a rather indecisive trading pattern between 1.2266 and 1.2104. For now, we expect these barriers to hold short-term.
News Headlines
The Polish central bank (NBP) kept its monetary policy stance unchanged and sent a stark warning to markets betting on the start of a normalization cycle and to dissenting voices from within. The policy statement stressed continued pandemic-related uncertainty and the assumed temporary nature of inflation running above the upper tolerance band around the 2.5% target. Even if inflation will remain this high in the coming months. Policy rates remain at ultra-low levels (0.1% base rate) while the asset purchase program holds its open-ended character. Even the threat to intervene in the FX market to strengthen the impact of the NBP’s message remains alive. The Polish zloty weakened after the press release with EUR/PLN rising from 4.45 to 4.47. Against this background, PLN might be losing the momentum generated in April/May.
The Bank of Canada remained side-lined as well though they are in a much different situation. At the previous meeting, they slightly scaled-down the net asset purchases to CAD 3bn/week. At yesterday’s intermediate meeting, they confirmed that the economy/inflation is behaving broadly as expected. With vaccinations proceeding at a faster pace, and provincial containment restrictions on an easing path over the summer, the Canadian economy is expected to rebound strongly, led by consumer spending. CPI inflation will likely remain near 3% through the summer but is expected to ease later in the year. Such ongoing strength and durability of the recovery is what the BoC wants in order to further reduce the QE pace, likely at the July policy meeting. The loonie didn’t respond to the BoC outcome with USD/CAD following intraday USD-gyrations and closing just above 1.21…
