Sunset Market Commentary

Markets

UK gilts outperform global peers today, dragging yields 4.6-6.5 bps lower in a bull steepening move. It started after this morning’s inflation numbers all but cemented a Bank of England rate cut (to 3.75% from 4%) tomorrow. All kinds of gauges missed expectations: headline dropped 0.2% m/m which lowered the 3.6% annual print to 3.2%, the slowest since March. The underlying series (ex. food and energy) mimicked headline dynamics with the 3.2% y/y here being a YtD low. Price growth in the services sector, a key worry for the hawks at the Bank of England due to its close ties with wages and the labour market, equally slowed to a YtD low of 4.4%. In October’s 5-4 close call for holding rates steady, governor Bailey casted the swing vote. He wanted proof that disinflation would resume after inflation had been rising from 1.7% in September 24 to 3.8% by September 2025. That happened in both October and November, readying Bailey for a position switch. The implied market probability for a rate cut rose from 91% to near-100%. Room for further policy normalization after Thursday is limited though given still too high inflation and yesterday’s PMI’s suggesting the economy holds up relatively well. There’s maybe one additional cut on the horizon. Sterling erases all of yesterday’s gains against the euro, lifting EUR/GBP back towards the 0.88 barrier. The YtD high of EUR/GBP 0.8865 remains nearby and serves as the first technical reference to watch.

FI in the US and Europe shows modest bear steepening. US rates add 1.3-2.3 bps, European swap yields up to 2.4 bps. The 30-yr swap tenor yesterday suffered from fear of heights after nearing the 2023 multiyear high but is ready to give it another shot. Except for a minor rise in oil prices we saw few reasons for long term yields to rise. It is perhaps testament to the strength of the underlying forces (eg. risk premia) driving the move. Real yields in Germany – which capture amongst others risk premia – just rose to a new 14-year high. Fed governor Waller hit the wires only to spread out his dovish wings: the labour market is very soft, inflation won’t reaccelerate and rates are still 50-100 bps above neutral, allowing for steady policy normalization (or is it easing?). Brent oil prices gain a tad to <$60/b on the news of the US ordering a blockade of sanctioned Venezuelan tankers and the threat to impose additional sanctions on Russia’s energy sector if the country would reject a peace agreement with Ukraine. The black gold remains mired near the lowest levels in around four years. Economic data today was limited to the German IFO (87.6 from 88) coming in to the low side of expectations, mainly as the expectations component disappointed. It wasn’t a major surprise after yesterday’s PMIs. Attention now turns to the US inflation numbers and the ECB policy meeting scheduled for tomorrow. FX markets ex GBP trade muted with some JPY underperformance ahead of Friday’s BoJ meeting. EUR/USD steadies around 1.173.

News & Views

The Confederation of British Industry’s monthly industrial trends survey showed the manufacturing output decline easing in the three months to December (weighted balance of -21% from -30% in the quarter to November). 15 out of 17 sub-sectors showed decreasing output with the fall being driven by chemicals, metal products and mechanical engineering. Activity was clearly held back by uncertainty ahead of the Budget. Significant headwinds remain nonetheless, with demand still soft, high energy, labour and regulatory costs squeezing margins, and uncertainty around key policies and global conditions continuing to weigh on confidence. Total (-32% from -37%) and export order books (-27% from -31%) improved relative to last month, though remain historically weak. Long run averages of both series are respectively -14% and -19%. Stock adequacy eased (+8% from +16%) but manufacturers report that inventories of finished goods remain more than adequate. Expectations for selling price inflation picked up (+19% from +7%), with the survey balance rising above the long-run average (+8%).

The Swedish Origo group published its quarterly inflation expectations survey conducted on behalf of the Riksbank. Interviewees expect annual CPIF (core) inflation at 1.6% in the year-ahead, at 2% in the twelve months thereafter and at 2.1% in year 5. In the September survey, short term inflation expectations were higher, at 2.1% for both year 1 and 2. Simultaneously, the survey paints a brighter economic picture with growth now expected at 2.3%-2.3%-2.2% for year 1, 2 and 5, up from 1.8%-2.2%-2.1% in September. The Riksbank’s policy rate path is still seen very gradually upward sloping from the current 1.75% towards 2.25%.