Sunset Market Commentary

Markets

Core bonds extended this week’s gains during European trading hours as the data drum echoed yesterday’s sound. Additionally, risk sentiment soured following dismal Chinese figures this morning. French inflation fell by 0.1% M/M in May (vs 0.3% consensus) with the Y/Y-figure come down from 6.9% to 6% (vs 6.4% expected). As was the case in yesterday’s Spanish and Belgian figures, energy prices were the main culprit though the inflation decline was more broad-based. German regional data soon pointed to a similar story with M/M inflation effectively down 0.2% and the Y/Y figure sliding more than expected from 7.6% to 6.3%. Again, energy inflation was the prime driver of this decline. Italian inflation, rising by 0.3% M/M and falling less than expected from 8.7% Y/Y to 8.1% was today’s exception to the rule. Data suggest downside risks for EMU headline inflation tomorrow, though the jury remains out on the core issue. They nevertheless don’t question the ECB’s drive to hike policy rates by another 25 bps mid-June while sticking to their hawkish guidance. The intraday bond rally grinded to a halt in the run-up to US trading. We don’t draw any firm conclusions yet though with monthly JOLTS job openings still to be released. We retain comments by Fed Bowman who said that “the residential real estate market appears to be rebounding, with home price leveling out recently, which has implications for our fight to lower inflation”. Earlier today, Cleveland Fed Mester in an interview with the FT argued in favour of another 25 bps rate hike at the June FOMC meeting. Changes on the US yield curve currently range between -3.8 bps (2-yr) and +0.3 bps (30-yr). German Bunds outperform with yield changes varying between -5.7 bps (5-yr) and -2 bps. In the sovereign scope, the Slovak Republic mandated banks to launch a new 10y benchmark in the near future (likely tomorrow). Existing trends in major FX crosses weren’t questioned with EUR/USD losing 1.07 on the combination of EMU CPI and risk aversion. EUR/GBP copied the move south in EUR/USD, testing yesterday’s low around 0.8630. In smaller currencies, the Turkish lira is the standout loser (EUR/TRY>22) while Scandinavian currencies try to fight back after recently setting multi-annual lows.

News & Views

The ECB published its semi-annual financial stability report today. Among the key findings are that uncertain growth prospects, persistent inflation and tightening financing conditions continue to weigh on the balance sheets of (especially debt-laden) firms, households and governments. Sector wise, the ECB singled out the real estate market with a particular focus on commercial property. House prices have cooled considerably though orderly. That could turn disorderly, however, if higher mortgage rates increasingly reduce demand. The ECB said that financial markets remain vulnerable to asset price adjustments. “Stretched valuations, tighter financing conditions and lower market liquidity might increase the risk of any adjustment becoming disorderly, particularly in the event of renewed recession fears.” The ECB also found that euro area banks proved resilient to stresses in the US and Swiss banks, thanks to strong capital and liquidity positions. It added that it is essential to preserve this resilience.

Polish prices stabilized in May. The 0.0% m/m outcome undershot a 0.3% estimate, delivering a downside y/y surprise as well: 13% vs 13.4% expected, coming from 14.7% in April. Fuel prices and utilities (electricity, gas & other) exerted a strong downward force with monthly declines of 4.8% and 0.5% respectively. Excluding this suggests that core inflation (to be released June 16) might be much more sticky. KBC Economics estimates it to be above 11% y/y, from 12.2% in April, leaving the central bank in the country no room to cut rates (6.75% today) anytime soon. NBP’s Kotecki, one of the few hawks in the monetary policy committee, in an interview on Monday said rates might not be slashed this year and even the next. Other members, including Maslowska, are using the recent zloty appreciation as an argument to bring forward a rate cut. The NBP governor Glapinski has repeatedly expressed hope for a first move by the end of the year. The Polish zloty today trades unchanged around EUR/PLN 4.53. In a broader perspective, the zloty appreciation recently hit strong resistance around EUR/PLN 4.50.