Markets
St. Louis Fed Bullard confirmed on Friday that the tapering debate started earlier this week and will continue in coming meetings. Personally, he’s on the side of upward inflation risks with a preference of hiking policy rates in 2022. Bullard’s comments reminded markets of Wednesday’s FOMC meeting which featured elevated signs of upward inflation risk and a willingness to act via higher policy rates by most governors in 2023 and by a large minority already in 2022. The FOMC and Bullard in two phases pushed the front end of the US yield curve (2y-5y) 9.1 bps to 13.5 bps higher as markets start discounting a first move by the Fed on interest rates. From a technical point of view, the US 2-yr yield exited the post-pandemic narrow sideways range (0.1%-0.24%) on the upside. The US 3y yield touch 0.5%, the highest level since March. This generous (interest rate) support at the front end of the US yield curve benefited the US dollar. EUR/USD slipped below several support levels to currently change hands around 1.1850 (vs 1.21 ahead of FOMC). Technically, the April/May upleg could face full retracement with support at the EUR/USD YTD low of 1.1704. The trade-weighted dollar in a similar stealth move is heading towards the 93.44 YTD high after taking out final significant retracement (62%) last Friday. Stock markets are starting to feel at unease given the prospect of an ending era of extremely generous monetary policy. Investors decide to take some chips off the table from a risk/reward point of view and given the proximity of all-time (US/recovery (Europe) highs. Main US indices lost 1% to 1.5% last Friday with European benchmarks even leaning towards 2% decline.
So far for the logic, explainable market moves. Based on the above, one would expect the US yield curve to show a (sooner than anticipated) bear flattening move. That’s not the case. The US 7-y yield serves as the pivot point between higher short term rates and falling long term rates. The longer end of the US curve already behaved rather strangely ahead of the Fed but the 14.4 bps (10-yr) to 17.3 bps (30-yr) decline afterwards is very peculiar. Underlying details show markets buying into the Fed’s temporary inflation narrative now that they indicated willingness to effectively act and not let the situation spiral out control. Inflation expectations fell some 15 bps. The odd thing is that the US real yield trades only 5 bps higher than ahead of the Fed meeting, implying either much lower US neutral rate than was the case in the past or serious doubts on the strength of the US economic recovery. Rotation plays out of stocks into bonds with as we approach the quarter end might distort the underlying picture as does the drawdown of the US Treasury’s TGA account. In any case, the huge outperformance of the long end of the US yield curve is something to carefully look out for. If that trend doesn’t end soon its questions our general narrative of a bright eco outlook, higher inflation (expectations) and monetary policy normalization.
News headlines
In France’s regional elections, the parties from both president Emmanuel Macron and Marine Le Pen disappointed in the first round yesterday. The traditional right is on track winning about 30% of the votes. The Le Pen’s National Rally comes second with 19%, almost 10 points down from the last election. Macron’s LREM is polling at about 10 to 11% nationally only. Voter turnout is estimated at only 32%, an all-time low. The second round takes place on June 27. The regional elections are closely looked at, as they come shortly before next year’s presidential elections.
Ebrahim Raisi is the winner of the Iranian presidential elections. The hardline cleric takes the place of the more moderate Rouhani and could complicate diplomacy and talks regarding the 2015 nuclear deal. A sixth round of discussions stranded yesterday in Vienna with parties saying significant gaps remain. Raisi is subject of US sanctions and Iran insists they must be removed as part of any pact. It also wants guarantees that future US governments won’t exit the deal the way former president Trump did in 2019. Brent oil hovers around $73.5/barrel this morning.
