Markets
With the eco calendar almost empty markets only had to cope with two topics: the potential consequences of the Evergrande credit debacle and the Fed policy decision. Regarding the first one, investors for now conclude that the impact for markets outside China, directly via credit exposure and indirectly via the broader impact on Chinese growth/Chinese demand for foreign goods, should be manageable. For a second consecutive day European equities, which are more sensitive to developments in China, outperform their US counterparts. European indices again recoup about 1%. Monday’s loss hasn’t been reversed yet, but a close of the EuroStoxx 50 north of the 4082 neckline would give some comfort. US indices gain about 0.5% shortly after the open. For now, this risk-rebound mainly occurred on equity markets. Some hard-hit commodities (Iron ore, copper, oil…) also entered calmer waters. The impact on bonds and FX is much more modest. These markets keep a wait-and-see bias ahead of this evening’s Fed decision. Both US and German yields are hovering around the flatline. Intra-EMU spreads narrow up to 2 bp (Spain/Italy). The US dollar mostly trades little changed (DXY 93.25, EUR/USD 1.1730). Remarkably, the usual FX safe havens, the Swiss franc and the yen, are parting ways. The CHF extends its comeback (EUR/CHF 1.0820). The yen eases with USD/JPY returning to the mid 109.50 area. Sterling remains in the defensive ahead of tomorrow’s BoE meeting. EUR/GBP is nearing the 0.8614 short-term top/resistance.
A small recap on issues the Fed needs to ‘clarify’ at this evenings policy announcement. Policy rates will remain unchanged, but change is coming ever closer regarding asset purchases. We favour a scenario of the Fed reducing the current pace of bond buying ($120bn p/m) starting from October (or November to keep at least most doves on board). The time table/pace of tapering also matters. We assume purchases to end mid-2022. Such a scenario might support real yields across the curve. Next question is how the end bond buying will roll-over into a genuine hiking cycle. Fed Chair Powel will try to separate both steps to maintain flexibility. However, some (regional) Fed members in the dots might show their preference for a tighter time table as they see rising inflationary risks. Two additional members changing their view might put the median expectation for a first rate hike end 2022. 2 or 3 additional hikes both in 2023 and 2024 in our view is a feasible option. Such a rather concrete perspective on the start and the first phase of a rate hike cycle, might raise interest rates especially in the 3y-7 y sector of the curve with some bear flattening at for longer maturities. This should also support a the short term momentum of the greenback.
News Headlines
The German Ifo institute in its Autumn 2021 economic forecast downgraded this year’s GDP prognosis from 3.3% to 2.5%, while raising it in 2022 from 4.3% to 5.1%. While contact-intensive service industries are recovering strongly from the coronavirus crisis, value added in manufacturing is shrinking due to supply bottlenecks for key industrial intermediate products. The high growth rate in 2022 is largely due to the low level of production of goods and services in 2021. In the course of 2022, the momentum of the overall economic recovery will decrease. The German inflation rate is likely to rise further to around 4.5% by the end of the year. Only in the coming year will it then gradually fall again and approach the 2% mark. The Ifo-forecasts are subject to some risks. A first significant downside risk stems from the assumed rates of infections and vaccinations. A second downside risk exist in connection with prolonged bottlenecks in the supply of intermediate products. Finally, there is also uncertainty about the direction of fiscal policy after this weekend’s German elections.
ECB Governing Council Member Muller said that discussing boosting the regular Asset Purchase Programme once Pandemic Emergency Purchases come to an end (March 2022) is an option, but such increase is by no means guaranteed. Given the currently very favorable financing conditions and the solid recovery, raising the APP volume in spring next year isn’t necessary the best way to avoid a cliff effect.
