The aggressive unwinding of the reflation trade halted on Friday. Core yields and equities rebounded after an accelerated setback (especially for yields). This morning, it looked that this milder sentiment could continue. Asian equities printed in green with Japan (2%) and China (1%+) outperforming after the PBOC on Friday reduced the Reserve Requirement Ratio. However, European investors didn’t reconnect and soon reverted to last week’s more guarded trading dynamics. ECB’s Lagarde this weekend flagged that the bank will soon (July 22) translate its new policy framework into its actual guidance and repeated that it was too early to start the debate on the exit of policy support. The European economy will continue to enjoy substantial ECB help, also beyond March 2022, which until now was marked as potential end of emergency support. Still, this prospect of prolongued support wasn’t unequivocally reassuring for investors. European equities drifted in negative territory. Admittedly, losses stayed modest and were reversed when the US joined. Core yields still feel the forces of gravity. German yields are easing up to 1 bp for the 10-y which stays below the -0.30% handle. The 10-y EMU swap yield is holding dangerously close to 0.0%. (0.015%!). The prospect of ongoing flexible ECB backing supported non-core EMU bonds with spreads narrowing up to 3 bp (Italy). Even with equities near record levels, US yields are easing modestly between flat (2-y) and 1.5.bp (30-y). Investors apparently aren’t worried that Treasury supply ($58 mld 3-y and $38 bln 10-y today, $24 bln 30-y sale tomorrow) will be picked up even at heavily discounted yields.
End of last week, the safe haven picking order among the majors was temporarily distorted. The yen followed the standard script, gaining on Thursday’s risk-off and declining on Friday’s risk/yield rebound. USD/JPY consolidates in the 110.20 area. The euro ‘surprisingly’ rebounded both on Thursday and Friday, but this ‘outperformance’ stalled. The 1.1895/80 resistance is a too high hurdle. Lagarde’s comments also suggest that EMU policy normalization will most likely lag the US and the UK. This is no surprise, but doesn’t help. EUR/USD is trading near 1.1850. The technical picture but remains fragile, inconclusive at best. Potential bigger policy divergence between the ECB and the BOE still isn’t able to push EUR/GBP below the 0.8540/30 support. The pair is trading directionless in the 0.855 area. Will UK eco update later this week finally break the stalemate? Briefly returning to the safe haven debate. After staying under the radar and underperforming the yen last month, the Swiss franc reclaimed its place in safe haven FX. Historically low German real yields are at least part of the explanation. With EUR/CHF returning well below 1.10 (currently 1.0850), the Swiss National Bank’s era of comfort didn’t last long.
The minutes of the Riksbank’s July policy meeting revealed some MPC members discussed a rate path that could indicate a rate rise at the end of the forecast horizon (2024) if inflation was at risk of overshooting the 2% target substantially and persistently. While inflation is seen somewhat above target at the end of the forecasting period, it isn’t an argument for making policy less expansionary at present, the minutes said. What matters are well-anchored inflation expectations. The RB believes that inflation temporarily above 2% after a long period of undershooting could contribute to this. The Swedish krone loses mildly in a slight risk-off context today (EUR/SEK near 10.20).
India’s inflation unexpectedly slowed to 6.26% y/y in June from 6.30% last month. Markets foresaw an acceleration to 6.59%. Food prices (+5.15%), fuel (+12.68%) and clothing (+6.21%) were the main contributors. While the reading is above the RBI’s upper limit of the 2%-6% target band, the slowdown allows the central bank to stay focused on growth as the country slowly emerges from lockdowns imposed to contain the third, most aggressive wave of the virus. Governor Das said already last week the RBI would look through the “transitory hump” in prices. One element to note however, are inflationary pressures from food as the monsoon season in key regions is only very slowly progressing, threatening the harvest.