The bull flattening trend that dominated over bond markets ever since the payrolls last Friday simply continued yesterday. The reflationary tale lost further momentum, not so much affecting equities (minor gains in US and Europe) but resulting in more yield declines at the long end of the US curve with 3.3 to 4 bps. The Fed meeting minutes delivered no surprises and, if anything, painted a more nuanced picture than the hawkish dot plot mid last month suggested as Fed officials still see a lot of question marks (on inflation, labour market, growth). One key takeaway is that taper talk will continue but that’s not new to markets. US yields broke below some important technical levels, including the 1.35% June low for the 10y (close at 1.316%). The 30y managed to stay north of similar support at 1.9259%. German yields tumbled 3 to 3.7 bps, sending its 10y to test key support at -0.30%. Both minor dollar strength and euro weakness plagued EUR/USD. The currency pair slipped below intermediate support of 1.181 to close at 1.179, the lowest level since early April. DXY (trade-weighted dollar) finished north of 92.51 support (92.64). Downward pressures brought EUR/GBP to 0.854, a level that acted as support many times already.
Asian mood is pretty dark this morning. Lingering market concerns over growth were given more substance by the Chinese State Council signaling a cut in the reserve requirement ratio (see below). Being the frontrunner in the economic recovery, doing so would potentially mark a pivotal point in the economic cycle. Chinese stocks underperform. The dollar holds steady. Other majors including the euro and especially the yen perform well. The Kiwi dollar lags the scoreboard after two strong days. Core bond futures have an upward bias amid cautious trading.
The economic calendar has to offer no other than weekly jobless claims in the US. We do however look forward to the ECB’s press conference this afternoon on the results of its strategic review. According to officials familiar with the matter, the inflation target was raised from “below, but close to 2%” to 2%. It is also anticipated that the ECB will allow overshooting the target to make up for previous misses as suggested recently by board member Schnabel. We expect the impact on markets to remain limited though. Such a review mainly has longer-term implications and a lot of it has already been priced in the euro and European yields anyway. What matters for today is how the Chinese signal will be digested by the rest of markets. It certainly touches a raw nerve but how much further should the bond repositioning go after the recent sharp moves? We think the yield decline might continue but slow from here, keeping the next technical references (1.21% in US 10y, -0.40% in German 10y) at a safe distance. If sentiment turns a bit less sour, EUR/USD in a daily perspective might hold up better too. The technical picture undoubtedly does bring a major advantage to the dollar though, so it would be wrong to assume EUR/USD is out of the woods already.
The Chinese State Council said the PBOC ‘will use monetary policy tools, including a cut to the reserve requirement ratio at appropriate timing to enhance financial support to the real economy, particularly to smaller businesses’. Such a step aims to help firms deal with the impact of rising commodity prices. Chinese authorities highlighting potential policy easing might indicate that authorities see a risk of weaker than expected data. In this respect markets look forward to the Q2 GDP data that will be published on Thursday next week. The yield on the 10-y China government bond dropped 4 bp to 3.0%. The yuan this morning is trading little changed at 6.4775.
In a speech addressing topics on the labour market, RBA’s Lowe again put forward that the bank wants to see the unemployment rate declining to 4%. This is seen necessary to lift wages and for inflation to return to the 2-3% target range in a sustained way. The unemployment rate currently stands at 5.1%. In line with last week’s policy decision, the RBA governor repeated that scaling down the bond purchases from A$ 5 bln to A$ 4 bln does not represent a withdrawal of policy support. Lowe reiterated the RBA assessment that it probably will take until 2024 for inflation to reach the target in a sustainable way.