Attention obviously turns to the FOMC meeting tonight. Fed Chair Powell stated in March that sustaining the US economic expansion is the Fed’s overarching goal. We expect the new reaction function of the Fed to reflect that stance. Instead of saying that the next rate move could occur in either direction, Powell will probably show clear determination to cut policy rates if eco data deteriorate further. That scenario of “insurance cuts” is discounted in rate markets, with forward curves pricing up to 4 cuts by the end of next year. It was also quite striking that Fed governors didn’t really downplayed market moves in the run-up to the FOMC meeting. The new dot plot is a big question mark. How will governors reflect the binary risk of willing to cut rates? We expect dots to shift towards market pricing, but they’ll retain some distance. The market implied probability of a July cut stands at 84%. The probability of at least two 25 bps rate cuts by the end of the year exceeds 80%. We don’t expect the Fed meeting to be the start of a profit taking move on the core bond market and that it will prevent a sustained USD rebound. EUR/USD 1.11 remains the line in the sand.

Markets digested yesterday’s ECB policy easing comments during an extremely calm trading day ahead of thre Fed meeting. Global core bonds simply took a breather after yesterday’s surge, especially in the German bund. The US yield curve bear flattens with yields changing from +3bps (2y) to +2 bps (30y). German yield changes vary from +2 bps (2y) over +4 bps (5y) to +3 bps (10y, 30y). Peripheral spreads narrow further with Italy and Greece outperforming (both -7 bps). FX markets oscillated near opening levels. EUR/USD currently creeps higher in technical trade to levels close to 1.12. Market moves are very gradual and remain limited however. The important Fed meeting holds currency and bond markets in check. Investors first want more clues as to how far the Fed is willing to go in sustaining the current economic expansion (i.e. how many rate cuts will Powell hint at?).

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After yesterday’s sharp and sudden ECB-driven decline, EUR/GBP kicked off European dealings in a shy recovery mode. The upward leg soon ran out of steam however. The couple returned to opening levels and posted additional, yet minor, losses after British CPI in May, if anything, marginally beat expectations. The EUR/GBP 0.89 is currently under test. Cable ekes out slight gains and is closing in on the 1.26 handle. A clear direction of the pound sterling is absent in the run up to this evening’s third Tory party voting round and especially to tomorrow’s Bank of England meeting. Markets are keen to see whether the BoE will cling on to it’s tightening bias amidst a global shift of central banks towards more monetary easing.

News Headlines

UK inflation in May decelerated slightly from 2.0% YoY to 1.9% on cheaper air travel and car prices. Core measures also declined a tad but a little less than expected (from 1.8% YoY to 1.7%, 1.6% expected). UK producer prices (May) and housing prices (April) were similarly lower compared to the previous month.

May inflation in Canada surprised on the upside with headline inflation accelerating from 2.0% YoY to 2.4% (0.4% MoM) with food, recreation and education offsetting a steep drop in energy and transportation prices. Gains for the loonie stayed limited though (USD/CAD near 1.336, -0.15%).


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