Sunset Market Commentary

Markets

Dire public finances suddenly turned the spotlights back on the UK today. The monthly August deficit, a once only second tier number for markets, came in at £18bn. That was way bigger than both markets but more importantly, the Office of Budget Responsibility had predicted (£12.5bn). Total deficit in the running fiscal year (starting in April) now mounted to £83.8bn, again well above OBR forecasts. It’s another blow to UK chancellor Reeves and ups the ante for the November 26 annual budget. Reeves needs to strike a balance between her pledge not to raise taxes any further and stick to the government’s promised investment plans while abiding to her self-imposed fiscal rules (ie. simply borrowing your way out is not an option). Today’s setback comes days after news that the OBR is expected to lower its productivity forecast, meaning less economic growth and therefore less tax revenue. UK gilts underperform. The 30-yr yield adds 4 bps currently. The Bank of England yesterday announced that it would sell less long-term bonds as part of its QT programme (which has been lowered in scale as well, to £70bn from £100bn). But that seems to be a drop on a hot plate. Yields in other core areas rise too, be it to a lesser extent. US rates add 1.2-2.7 bps, leaving further behind the recent lows in the wake of the Fed’s rate cut on Wednesday. We’re closely watching the inflation expectations component, which is nearing the recent highs around 2.5%. There’s some buzz again around the Fed’s 2% target. Fed’s Kashkari said today the central bank is not ok with 3% inflation but some say Wednesday’s precautionary move (to support the labour market even though inflation is still too high and not expected to drop below target) is a sign the Fed is willing to tolerate higher inflation. European rates add a few bps as well with Bunds slightly underperforming vs. swap. Between euro area countries, the French spread has been trading higher than Italy’s every day all week in what is nothing less than a historical shift. The US dollar has a slight upper hand. DXY rises to 97.7 in a three-day win streak. EUR/USD drifts south to 1.175. Sterling loses ground as well with EUR/GBP pushing beyond 0.87(1). The Japanese yen pared early gains to trade flat around 148. The BoJ stood pat this morning but in a 7-2 split. The dissenters wanted to hike to 0.75%, saying that the 2% price target has been achieved.

News & Views

Previewing next week’s policy decision, it is widely expected that the MNB will leave its policy rate unchanged at 6.5%. Headline inflation (4.3% in August) has eased toward 4%, but underlying measures such as core inflation and inflation expectations remain uncomfortably high, leaving no room for a premature move. At the same time, the economic activity offers no strong support for policy tightening. Retail sales and underlining domestic demand is fragile. Growth remains subdued overall (0.4% Q/Q in Q2, but only 0.1% higher activity compared to the same period last year). Despite weak growth, MNB has no choice but to keep its focus on inflation. Positive news for policy makers: the forint performed rather well of late with EUR/USD moving toward 390. This should help to ease second round inflation effects. However, the forint remains vulnerable, amongst others as market position is quite strongly skewed HUF-long leaving the currency exposed to external shocks. In a somewhat longer term perspective, KBC assesses that a chances on a MNB rate cut are slim this year. A narrow window for a symbolic 25 bps cut in December could open if three conditions are met: 1. Rating agencies in their autumn reviews have to leave the Hungarian Credit rating unchanged; 2.The Fed has to continue policy easing global yields spreads; 3. The forint strengthening toward EUR/HUF 385 would give the MNB some room of maneuver. Even so, such a move won’t mark the beginning of a new easing cycle, but serve as a signal of flexibility, an acknowledgment that domestic and external conditions had aligned sufficiently to justify a modest step.

According to the German IFO institute, sentiment in residential construction in Germany clouded over again in August, with the index falling from minus 24.2 to minus 26.3 points. Both companies’ expectations for the coming months and their assessments of the current situation worsened. “The cautious upturn in sentiment of recent months is on hold,” said Klaus Wohlrabe, Head of Ifo Surveys. He assesses that it will take time before the increase in building permits is reflected in the order books. In a broader perspective, Ifo still sees companies struggling with weak demand. The share of companies with a lack of orders eased slightly but at 45.7% remains at a high level.