Sunset Market Commentary

Markets

At the start of the new trading week markets continued to ‘mark-to-market’ the recent flaring up of hostilities between the US and Iran. Aside multiple other sources of disagreement, the key point of the current re-escalation clearly concerns the management of (free?) traffic across the Strait of Hormuz. The US until now advocated a free transit, but even President Trump in an interview suggested that it could get paid for guarding the passage. Iran on the other hand wants to hold control over the traffic via permissions and passage only via (Iranian) approved corridors. Both parties for now avoid a return to an outright war as it occurred before signing the Memorandum of Understanding/cease-fire mid-June. From a market point of view, the oil price regained its status as guide for other markets. At $78/b Brent oil again trades well off the corrective lows touched early this month, but at the same time they show no outright panic yet. As a closely watched pointer especially for European energy costs, the reference Dutch natural gas contract (TTF) today returned north of €50/MWh (currently €51), the highest level in over a month. If sustained, these kind of levels might again erode the more benign inflation picture as it emerged from the June (EMU) inflation data. Developments can change quickly in both directions, but for now the by default momentum is for yields to grind higher. In a session devoid of any other market-relevant economic news, German yields currently add between 5 bps (2-y) and 2 bps (30-y). Money markets discount a 90% probability for a next 25 bps ECB step by September. UK Gilts even slightly underperform with yields rising between 9 bps (2-y) and 5.5 bps (30-y) as higher inflation expectations question the BoE’s wait-and-see stance and as markets still try to get some insight in the budget intentions of the new Burnham government. US yields also trade with an upward bias, but in a more modest way than in the UK and Europe. US yields add between 1-3 bps across the curve. US June CPI figures (tomorrow) and Kevin Warsh’s first Testimony for Congress (tomorrow and on Wednesday) are first ‘autonomous’ US topics to guide US interest rate markets. At least on (European) equity markets, the reaction to the new flaring up of Middle East tensions happens orderly. The Eurostoxx 50 trades little changed. US indices open mixed with the Nasdaq underperforming (-0.60%), capturing some of the nervousness in chip-stocks in Asia (in particular South Korea), this morning. In line with recent price action, geopolitical noise hardly leaves any traces on the major USD cross rates. DXY trades little changed near 100.9. EUR/USD even gains marginally in a technically irrelevant move (EUR/USD 1.1425). The yen reverses most of Friday’s gains as markets understood that it is premature to expect a change in the strategy of the Government Pension Investment Fund to yield any positive flows to support Japanese government bonds and/or the yen. USD/JPY rebounded north of 162. Sterling slightly underperforms the euro, with EUR/GBP trading near 0.853 despite a rising interest rate advantage for the UK currency.

News & Views

Sources told Reuters that Japan’s Government Pension Investment Fund, the world’s largest, has no immediate plans to change its target asset allocations. Markets jumped to such a conclusion after finance minister Katayama last Friday said the government was pondering ways to encourage pension funds, including the GPIF, to make substantially greater investments in Japanese financial assets. It prompted sudden JPY, JGB and Japanese equity strength on expectations for potentially huge capital flows to be repatriated back into the local market. What the likes of GPIF could do, the sources said, is to work within existing allowable ranges compared to the benchmark portfolio. For domestic bonds, for example, the fund is allowed a 6 ppt deviation range around the 25% target allocation. Both the yen and JGBs today give back about half of Friday’s gains.

Indian inflation accelerated more than expected to 4.38% in June from 3.93% in May. That brings it above the central bank’s 4% (+/- 2 ppt deviation range) mid-point target for the first time in about one-and-a-half years. Food inflation, amongst others, quickened to 5.32% with a strong spring harvest being offset by expectations for El Niño related supply disruptions. Transport prices jumped as well, from 1.75% to 4.31%. Prices in restaurants and accommodation meanwhile are picking up a 50% increase in commercial cooking gas prices at the start of the month. Core inflation held at 3.9%. The central bank left its policy rate unchanged at 5.25% during last month’s meeting but raised its inflation forecast to 5.1% for the fiscal year ending in March. Governor Malhotra said monetary policy would only respond if price pressures broadened although it is watching oil and food price developments closely.