Markets
With few data scheduled for release and the focus backloaded toward the end of the week, investors built on yesterday’s trading dynamics. US and European inflation expectations continue rising, with Europe taking the lead. The 10-y euro inflation swap touched 2.20%. Markets apparently aren’t convinced at all that the ECB on Thursday will conclude that inflation expectations are (more than well) anchored. The rise inflation expectations coincides with a further decline in real yields. The US 10-y real yield returns below -1.0% (-1.05%). The German real yield is sinking ever deeper in uncharted territory (-2.15%!!). For nominal yields, this results in a further curve flattening with the US 2-y yield rising 1.5 bps while the 30-y eases 2.0 bps. The German curve even continues an outright bull flattening with the 30-y yield shedding 2.0 bps. It’s far from clear how long this trend of lower real yields can/should continue. At least for now, together with acceptable corporate earnings, it facilitates a favourable equity sentiment. European equities show gains of up to 1.0%. The cycle top in the EuroStoxx50 (reached mid-August) is again within reach. US indices (S&P 500, Dow) even open at a new record. Buy-on-dips still shows remarkable resilience.
Moves in the major currency cross rates are limited. The DXY-USD index trades little changed in the 93.75/80 area. USD/JPY regains the 114 barrier. We assume this is mainly due to the risk-on rather than a result of interest rates. In a similar narrative, EUR/USD resists the decline in EMU real yields, hovering in a tight range just north of the 1.16. Even so, the broader picture still looks fragile with 1.1664 a tough hurdle going into Thursday’s ECB policy meeting. The better global sentiment also arrested the decline in CE-currencies. EUR/HUF stabilizes near 365.50. The Czech koruna (EUR/CZK 25.70) and the zloty (EUR/PLN 4.6050) even try a (very) cautious comeback.
Diverging underlying yield dynamics obviously benefited sterling. EUR/GBP drifted towards the 0.8421 recent low with CBI retail sales providing the final push in the GBP back. Surging retail sales pulled the pair close to 0.84 with GBP/USD testing the recent highs near 1.3835. Next week will be interesting from a UK perspective. UK Chancellor Sunak will set out budget plans tomorrow which will include a higher national living wage and an end to the public sector pay freeze. Better-than-expected growth forecasts imply improved public finance data and allow Sunak to focus more on spending. Such outcome could enhance short term sterling gains. The benchmark for UK trading comes on Friday when Brexit minister Frost meets with EC VP Sefcovic to take stock on talks about the Northern Ireland protocol. A less vigilant tone could further support sterling, especially against a weak euro. Finally, the Bank of England meets next week with an outside chance of an early kick-off to the tightening cycle. Next important support in sterling stands at 0.8277/0.8310 which are the 2019/2020 lows.
News Headlines
The German government slashed growth rates for this year from 3.5% to 2.6%, according to Reuters sources familiar with the decision. It has done so due to supply problems, including scarcity in semiconductors and intermediate goods that are crucial to German manufacturing. Recently, the European Union also warned for shortages in magnesium, an essential component for aluminum as Chinese exports to the bloc have slumped. German growth was revised up for 2022 though, from 3.6% to 4.1% before normalizing to 1.6% in 2023. The government holds the view that the inflation is temporary and sees price increases easing to 2.2% in 2022 and 1.7% in 2023.
The US junk bond market grew to an unprecedented $1.5tn, FT reported based on ICE Data Services. A record 149 companies already joined the high-yield bond market so far this year, already dwarfing the previous record in 2013 (over 120). In a global low-yield environment, high-yielders have particular attention from investors that seek to put huge cash piles to work. The IMF recently warned however that rising financial leverage could exacerbate existing vulnerabilities in the financial system. At the same time, the FT reported that investors start noting the challenge of conducting a proper due diligence on the companies they lend to because of the huge volume and short time between the launch and completion of new deals.
