Markets
Yesterday’s ECB in a nutshell: The central bank keeps ignoring persistent inflationary pressures but markets don’t. Investors assume the longer Frankfurt withholds a policy response, the tougher it’ll have to react eventually. This prompted (real!) German yields to rise in the wake of the meeting. Two additional elements aided the yield jump. First, despite having several strong arguments at her disposal, Lagarde only very modestly pushed back against markets pricing in rate hikes at the end of 2022. Secondly, the ECB chair was for the first time pretty vocal on PEPP formally ending in March, even before the actual discussion in December. The German yield curve bear steepened with changes going from +2.3 bps (2y) to 4.2 bps (10y). Peripheral spreads rose as much as 7 bps in Italy. Caught in the slipstream, US yields rose at the long end of the curve while the shorter end faced conflicting signals from below-consensus US Q3 growth. Changes ranged from -1.3 bps (2y) to 3.8 bps (10y). With the euro enjoying real rate support and the USD in the defensive on growth and the upbeat sentiment, EUR/USD jumped from the 1.16 support zone beyond first resistance of 1.1664 (August low) to close at 1.1681. The trade-weighted DXY gave up mirror support at 93.73 (August high) again. The stronger euro propelled EUR/GBP north of 0.845 and to a test of 0.8472 (April interim low).
Barring disappointing Japanese data and the RBA again looking away from the yield on its reference bond again soaring 25 bps (see below), Asian-Pacific news is scant. Stocks trade mixed with Australia underperforming. Core bonds continue yesterday’s correction lower. The Japanese yen together with the US dollar is marginally firmer. EUR/USD sticks north of 1.1664 though.
Today’s EMU inflation will probably make another dent in the ECB’s temporary narrative. Headline price increases are seen accelerating to 3.7% y/y. Core inflation might stabilize at 1.9%. Yesterday’s strong readings in Germany and especially Spain suggest upside risks. We wouldn’t exclude a positive surprise in European GDP numbers either (2.1% q/q expected) given the strong French beat this morning (3% q/q vs 2.2% with even an upward revision to Q2). That would bring about the perfect environment for (real) European yields to continue yesterday’s rebound from the historical lows and flavour euro trading. We’re looking at first resistance in EUR/USD at 1.1695/1.1708 (38% retr. 2020 low – 2021 high/March 2021 interim low) followed by the 1.175 area. We assume trading in EUR/GBP will be driven in similar fashion. We’re watching 0.8472 as a first resistance here.
News headlines
Italian Prime Minister Mario Draghi proposed the 2022 budget, aiming to reduce the budget deficit while at the same time reducing taxes and raising the retirement age. From €12 bln of tax reductions €8 bln of corporate and tax cuts for individuals aim to reduce the tax wedge between what employers pay and the final amount that employees receive. In a longer term perspective, Draghi indicated that tax cuts could amount to € 40 bln over the 2022/2024 period. The new budget targets a deficit of 5.6% of GDP next year down from 9.4% this year. The government expects growth of 6.0% this year and Draghi indicated that policy should aim to maintain a higher structural growth in the future. In a temporary arrangement, the retirement age was raised by 2 years compared to the current so-called ‘quota 100′ system in which retirement was possible from the age of 62 with 38 years of contribution.
The Reserve Bank of Australia abstained to intervene in the bond market to defend its 0.1% yield curve control target of 0.1% for the 04/2024 government bond. Yield on the bond spiked to 0.77% currently. In the same context, markets now start to discount a RBA rate hike by the spring of next year, while the RBA until now pledged that rates will have to stay at the current level until 2024. The market repositioning comes as markets look forward at the RBA policy meeting on Tuesday next week. The Aussie dollar gains marginally to the AUD/USD 0.7550 area this morning.
