Markets
Core bonds started the year on the backfoot, extending the U-turn which started in the final trading week of the year following an astonishing December rally. German yields rose by 4.4 bps (10-yr) to 5.5 bps (2-yr) while US yields added 4.3 bps (30-yr) to 7.9 bps (3-yr). From a technical point of view, both the US Note future and German Bund future trade near the lower bound of steep upward channels. That bond rally is testimony to investor confidence in a goldilocks scenario: avoiding a recession while inflation returns to 2% inflation targets, allowing central banks to switch from rate hikes to rate cuts. The Fed at its December policy meeting embraced such scenario while the ECB was more reluctant, preaching higher-for-longer. Money markets in any case went a very long way in discounting a change of heart at central banks, pricing a cumulative 150 bps of rate cuts in both the US and Europe with cutting cycles respectively starting in March and April. While it might be a little early to fight December market momentum, we believe these normalization bets are way overdone. The NY-shortened trading week could immediately challenge or confirm last year’s turn. The US manufacturing ISM, JOLT job openings and Minutes of the pivotal December Fed policy meeting are scheduled for release today followed by ADP employment change and weekly jobless claims tomorrow and payrolls and non-manufacturing ISM on Friday. Anything bar big disappointments could trigger some profit taking on bond positions with investors returning to more neutral positions as 2024 gets going and awaiting more central bank guidance. Richmond Fed Barkin is the first one today to comment on the economic outlook. The European agenda centers around national (tomorrow) and aggregate (on Friday) inflation numbers for the month of December. Statistical base effects are expected to interfere with the disinflationary process, lifting headline inflation back above 3% Y/Y. This development should back the ECB’s higher-for-longer talk and could take some air out of the bond rally as well. Higher bond yields blocked stock market momentum yesterday. The EuroStoxx50 went for a test of last year’s high in the open, but eventually closed 0.2% lower. US losses reached up to 1.6% for Nasdaq in a tech-led setback. The dollar loved the combination of higher yields and some risk aversion with the trade-weighted greenback rallying from 101.42 to 102.20. Technically, DXY stays trapped in the downward trend channel since early November. EUR/USD fell from 1.1045 to 1.0942. A firmer floor below core bond yields could help a more firm bottoming out pattern in the dollar as well.
News & Views
In his New Year address to the nation, Czech President Petr Pavel advocated that it is time for the country to begin making concrete steps to fulfil its obligation to adopt the euro. He assessed that despite ongoing discussions about advantages and disadvantages of the euro for a country with an open economy that is highly reliant on exports, its position in the center of Europe makes the adoption of the common currency a ‘logical future’. For now, the President’s call is mainly a political statement, with no direct implications. The current government officially takes the line that it intends to meet the Maastricht criteria for adopting the euro as soon as possible, but didn’t set out any specific time frame. The economic confidence index of the UK institute of Directors dropped from -21 in November to -28 in December, the lowest level since August. Even as the overall index declined, business leaders in general were more upbeat on their own activity. Even so, the decline of the index caused the policy director at IoD , Roger Baker, to advocate an early BoE rate cut: “With inflationary pressures abating, business is in dire need of a boost if it is to help drive meaningful economic growth in 2024”.
