Mon, Oct 25, 2021 @ 13:27 GMT
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Sunset Market Commentary


Markets pondered the way forward in the wake of the ECB and especially the surprise CPI reading yesterday. US real yields tumbled after US inflation rose to 5% y/y. A deep dive in the data showed that, apart from a maximum base effect, inflation was mainly driven by categories associated with the economic reopening. The Fed is supportive of the view that this won’t have long-lasting or even permanent effects on price developments. Markets tend to draw the same conclusion. In this vein, one could expect that trading narrative in the run-up to the Fed policy meeting (with new staff projections) to remain in place. That only held for stock markets. European equities advance about 0.8% while Wall Street rises 0.1-0.4% on an unchanged holy combination of easy monetary policy and extremely low volatility. The Vix hit a new post-pandemic low. US yields are rising, licking their wounds after yesterday’s blow. The curve is bear steepening with changes varying from 0.6 bps (2y) to 2 bps (10y). Because of today’s moves, the lower bound of the downward trend channel in the 10y yield, which coincides with the 38.2% retracement of the March 2020-2021 rise, holds going into the weekend. The German Bund outperforms in a catch-up move with Treasuries after the European close yesterday. German yields at some point fell more than 3.5 bps at the long end of the curve before paring the losses to 2.2 bps (10y) and 3 bps (30y). Some hawkish comments from ECB’s Knot had a temporary impact only. He said upside inflation risks have slipped into the outlook, thereby revealing he was probably one of the “couple of” governors with “diverging views” ECB president Lagarde referred to at yesterday’s policy meeting. Peripheral spreads tighten 1 (Italy, Spain) to 4 bps (Greece).

If markets really trust the Fed not to take action anytime soon, then the dollar sure isn’t hampered by it. The greenback held remarkably strong already yesterday, even as real yields dropped 10 basis points. With US yields actually rising today, the USD is having a very good day vs. peers. EUR/USD falls below intermediate support at 1.215 to trade in the 1.213 area. Key support ahead of the Fed policy meeting lies at 1.21. The trade-weighted DXY bounces off 90 and is developing an upward sloping trend channel. Dollar strength also hurts gold (slipping back below $1900/ounce) in one of the few typical correlations that does hold. EUR/GBP attacked the 0.86 in early trading after disappointing UK industrial production figures but soon reversed course on marginal euro weakness. The pair is headed for a close sub 0.86.

News Headlines

The central bank of Russia today raised its key interest rate by 0.5ppt to 5.5%. This was the third hike this year as the bank aims to slow a faster than expected rise in inflation. As the Russian central bank judges that the economic recovery from the pandemic ‘can lead to a more substantial and prolonged deviation of inflation upward from the target’, this creates the necessity of further increases in the key interest rate at the upcoming meetings. Inflation climbed to 6.0% in May and the central bank only expects price growth to return to the 4% target in the second half of 2022. The ruble extended gains after the policy announcement. EUR/RUB dropped to the 87 area. USD/RUB is changing hands in the 71.75 area.

The Turkish lira rebounded further today. Yesterday, the Turkish currency profited from a further substantial decline in core/USD yields. This morning, the Turkish Treasury and Finance Minister labelled the rising divergence between producer and consumer prices as quite disturbing as exchange rate pass-through effects and rising global commodities play an important role in the steep rise in producer prices. To some extent, the rebound in the lira might also be supported by some investors anticipating on an possible easing of tensions between the US and Turkey as US president Biden and Turkish president Erdogan meet in Brussels on Monday. EUR/TRY currently trades at 10.19, compared to the 10.55 area at the start of the week.

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