Markets
In ‘normal times’, the ECB publishing the results of its policy review would be the dominant headline on markets (cf infra). Evidently, there was plenty of analysis on this topic on the newswires, but it was no factor of significance for trading. Investors had to cope with other issues. Growing doubts on the post-pandemic recovery continue to unsettle the hoped for calm during the summer holidays. This morning’s ‘call’ of the Chinese government for the PBOC to consider a further cut in the Reserve Requirement Ratio (RRR) only reinforced investors’ nervousness. Markets switched to outright risk-off modus. Over the previous days, especially US equities weathered uncertainty on FI and FX markets, but that has changed today. Spill-overs from Asia/China triggered a self-off on European equity markets with most indices losing 2%/3%. In US, the S&P and the Nasdaq yesterday still touched new historic record levels intraday, but indices are ceding up to 1.6%. The Nasdaq (tech) outperforming cyclicals due to lower long term yields today also doesn’t work anymore. The curve flattening in core bond markets simply continues, even as the pace of the decline eased as US traders joined the action. German yields currently decline between 0.7 bp and 3 bp. This looks modest maybe, but after recent decline, the technical picture is severely damaged with the German 10-y yield below -0.30%. The 10-y EMU swap dropped (temporarily) below zero! Until yesterday, peripheral EMU bond yields followed the decline in core yields, but also this pattern didn’t survive the risk-off move anymore. 10-y spreads of the likes of Spain, Portugal, Greece and Italy are widening 3-4 bp. Similar picture in the US, with yields declining between 1.5 bp (2-y) and 4.25 bp (30-y). The move was driven by a decline in inflation expectations, illustrating the unravelling of the reflation trade. Cyclical commodities (copper, oil) are also falling prey to further profit taking.
The risk-off today evidently also affected FX trading. The yen remains the preferred save haven with USD/JPY drifting further below the 110 mark (109.70). Smaller, less liquid currencies (HUF, CZK, PLN) and commodity related currencies (CAD, AUD, NOK) also suffered as one expects in this kind of risk-off world. Highly remarkable, the euro today outperformed the dollar. EUR/USD jumped from sub-1.18 levels this morning and currently trades near 1.1855. The explanation is not that evident. The new ECB policy framework (higher inflation), if anything, is euro negative rather than euro supportive. Profit taking on recent euro shorts and/or unwinding of carry trades funded in the low-yielding euro are possible explanations. Even so, EUR/USD still trades within a ST downtrend channel. The technical picture hasn’t profoundly changed yet. In a similar move, EUR/GBP rebounds north of 0.86.
News Headlines
Hungarian inflation unexpectedly accelerated 0.6% m/m to hit 5.1% y/y in June vs. 5.1% the month before. Core inflation rose as well from 3.4% to 3.8% amid broad-based price gains, including in the services sector. It means inflation remains well north of the central bank’s 3% target with a +/-1ppt tolerance band. The MNB signaled it would raise rates as much as necessary to cool down inflation towards target and until inflation risks, now tilted to the upside, are balanced again. It did so in June (+ 30bps) and is likely to do so again in July and August. The Hungarian forint is under heavy selling pressure for a third day straight with EUR/HUF jumping to 358.45. Even if markets believe the MNB’s inflation pledge, it’s not enough to counter the general sharp sell-off in risky assets today.
The ECB presented its new policy framework today. It changes its inflation target from “close to but below 2%” to just 2% over the medium term. It will allow for temporary fluctuations. More persistent deviations will be viewed as equally undesirable on either side of the 2% and will prompt action, meaning the target is symmetrical. The ECB will also add the cost of owner-occupied housing to the inflation measure to more accurately reflect the actual cost of living. (The impact of) climate change will be incorporated in risk modelling as well as serve as a new criterium in both the collateral framework and (corporate) bond buying programmes.
