We saw flatter yield curves this week on a string of weaker than expected US data releases. Particularly the housing market is increasingly getting attention as the surge in mortgage rates weighs heavily, with new home sales down 10.9% in September, and also prices trending lower, which could soon be reflected in consumer demand. This also weakened the dollar which traded back around parity vs. euro as markets start to price in a potentially slowing of the tightening pace from the Fed. The tendency in equity markets that “bad data is good data” as long as yields drop continued, and stocks overall had a good week.
As widely expected, the ECB hiked its policy rate by 75bp and guides markets for further rate increases ahead. ECB will set the hiking pace with the economic outlook in mind, which is a clear indication of a slowing hiking cycle, and the market also priced out some almost 25bp of ECB hikes. The ECB also announced changes to the TLTRO terms, which will cause a significant drop in excess liquidity already from 23 November. Danmarks Nationalbank followed suit but only with 60bp in order to lift EUR/DKK off the low levels for good.
The economic contraction in the euro area continued for the fourth consecutive month, with October PMI declining further to 47.1. The contraction was driven particularly by a weaker than expected manufacturing sector. Germany is probably the weakest link, and Ifo data also confirms that Germany is headed for recession in H2. Supply bottlenecks do in fact show further signs of easing, but the weaker demand environment does not yet seem to have weakened firms’ pricing power noticeably, which leaves inflation pressures high.
After continuous weakening of the yen, the Bank of Japan (BoJ) has intervened in the FX market several times during the recent week. At the same time, the BoJ injects yen into the market to defend its yield curve control, while the government prepares a USD 200 billion (4% of GDP) spending package to ease the pain from energy bills.
Next week, the FOMC meeting is the main event for markets. It is too early to turn soft for the Fed, and we look for a 75bp hike and hawkish communication. We also expect to see a relatively strong jobs report later next week. In the UK, the Bank of England will also have to tighten further to bring down inflation and wage growth.
In the euro area, the highlight will be the HICP figures for October. Given strong underlying inflation pressures, we expect core inflation still trending higher to 4.9%, and HICP inflation likely jumping above the 10% mark. GDP figures for Q3 might show that a recession has started to take hold in H2 22, but a late rebound in industrial production amid easing supply bottlenecks leaves upside risks. In China, we will look out for PMI data, and we see some downside risks as weaker exports now add to the headwinds from the property crisis and zero-Covid policy.
