Sunset Market Commentary

Markets

In the run-up to the ECB policy decision, the list of core EMU bond yields featuring ‘the highest level since’ label grew ever longer. At the (very) short end of the curve, the 2023/24 post-corona highs still survive as ‘aggressive’ policy tightening at that time still outpaces expectations on what is deemed necessary to curb current, mostly energy related supply-shock. Still the 2-y EMU swap and Bund yield earlier this week surpassed the highs since the start of the Iran conflict. The 2-y swap topping the 3% mark suggests markets are ever more pondering some kind of higher-for-longer scenario unless energy prices return to more comfortable levels in a not that distant future. With hostilities in the Middle East intensifying, brent oil nearing the $100 p/b reference and the EMU Dutch gas reference contract at the highest levels seen since the start of the conflict (€63 p/MWh), markets consider avoiding a higher for long scenario as growing ever more difficult. For Bunds, the ‘tipping point’ to overcome the post corona peak levels currently hovers near the 5-y maturity. From there on, the reference goes back to 2011 (30-y) or even 2008 (5-y), with ‘decompression’ of risk premia and fiscal sustainability probably playing in the background next to uncertainty on inflation premia. Another symbolic breach: the French 10-y yield this morning briefly surpassed the 4% barrier for the first time since…2009! Somewhat of a similar narrative for US bonds yields. In the US oil/energy prices play somewhat of a more modest role, but over there domestic eco strength also is still in play. The US 2-y yield at 4.34% is still somewhat further away from the 5% 2023 top. For the 30-y the multiyear top from May also is only a whisker away (5.18% currently vs 5.2% in May), which in turn was the highest since… mid 2007! Of course, central bank policy mostly determines the short end of the curve, but a too loose approach probably won’t help to contain financial stability and inflation risks at the long end of the curve.

In this context, the ECB today decided on monetary policy with market looking for guidance, or at least for some clarification on the bank’s reaction function in the light of the scenario reference that was put in place/updated at the previous meeting. The ECB as expected left its policy rate unchanged at 2.25%. It stressed the volatile nature of current moves in energy prices but ‘admitted’ that they currently stand close to baseline scenario of the June staff projections. In this context, the bank still sticks to a meeting-by-meeting end data-dependent approach as it closely monitors the intensity and the duration of the shock as well as its indirect and second round effects. This of course is no commitment on any particular rate path. Even as the decision was unanimous, Lagarde at the press conference admitted that some members asked themselves if a hike was needed. In this context, markets didn’t see any reason to backtrack on its positioning of a next rate hike in September (92%) and other 25 bps step being almost fully discounted by the end of the year. Lagarde on a question also indicated that markets understand the ECB reaction function well. In a daily perspective, German yields add between 4 bps (2-y) and 1.8 bps (30-y). US yields are rising between 6 bps (5-y) and 4 bps (30-y) with yields pushing slightly higher intraday after comments from president Trump that the US will hold Iran responsible for Houthi strikes, suggesting no de-escalation in the near term. Brent oil at $99.5 p/b is only a whisker away from the $100 barrier. On FX markets, USD finally gains some momentum (DXY 101.45; EUR/USD 1.138).

News & Views

Czech president Pavel vetoed a bill that would have eased the country’s fiscal rules by widening the room to raise spending without parliamentary approval. The proposal foresaw exemptions for road, rail, nuclear power plants and dam projects to be included in the budget deficits as well as extended an exemption given to defense spending if it exceeds 2% of GDP. The bill would also allow the government to raise spending by up to 10% under loosely defined security threats. Czechia’s independent budget watchdog had called the proposed changes a fundamental weakening of fiscal discipline. Pavel echoed those concerns, saying it threatens long-term fiscal sustainability. The Czech budget deficit fell to 2.1% last year.