Markets:
Price action on global markets followed yesterday’s roadmap. Core yields continue marching north. Commodity indices (CRB), mainly driven by energy sub-components (oil, natural gas, …) reminded markets of persistent (supply driven) inflationary pressure. It is unsure how decisively central banks will (be able to) react to the kind of inflation that is to a large extent independent of the domestic economic performance. BoE’s Bailey yesterday at least suggested the BoE considers taking some ‘pre-emptive’ steps to contain unwarranted second round effects. Uncertainty on central bank’s reaction function probably explains way the rise in (US) yields is more or less equally divided between real yields and inflation expectations. The US curve further bear steepens with yields rising between 3.25 bp (2-y) and 9.5 bp (30-y). The rise in the two year yield is partially due to a benchmark change. Even so, it suggests markets are ever more considering a scenario where CB’s might be forced to raise rates earlier than deemed possible until now. The lingering debate on the US debt ceiling also doesn’t help Treasuries (cf infra). The German yield curve also bear steepens with yields rising between 1.2 bp (2-y) and 3.5 bp (10-y). This rise was solely due to higher inflation expectations, with the 10-y EMU inflation swap rising 5 bp to 1.90%. At the September press conference, ECB Lagarde indicated that the 1.75% level in the 5Y5Y forward inflation swap was one (of several) pointer(s) on the ECB’s inflation radar (currently 1.81%). Even so, at the opening of the ECB Forum, Lagarde repeated the mantra that most of current inflation is temporary and that the ECB will maintain supportive financing conditions. For now, the impact of higher core yields had only limited impact on peripheral bonds. Even so, Italy for the 3th consecutive day underperforms with the 10-y spread again widening 3 bps. A continuation of this pattern could complicate the ECB’s aim for equally supportive financing conditions across the EMU. Over the previous days, there was no one-on-one link between higher core yields and the performance of risky assets/equites. However, especially European indices today feel growing headwinds (EuroStoxx 50, 1.4%). US indices open with losses of 0.25% (Dow) to 1.3% (Nasdaq). …
The combination of a wider ST USD-EMU interest rate differential and rising EMU inflation expectations logically puts EUR/USD under pressure (1.1680 area). The 1.1664 support is at high risk. Sterling again failed to profit further from yesterday’s ‘hawkish’ comments from chairman Bailey. On the contrary, his colleague Catherine Mann at the ECB forum subscribed the thesis of ‘transitory inflation’. EUR/GBP even jumped north of 0.86(2), testing short term resistance. The rise in core yields again inflicts big damage for CE countries with especially the forint (EUR/HUF 359.75) and the zloty (EURPLN 3.63) in heavy weather.
News Headlines:
St.-Louis Fed Bullard ruffled his hawkish feathers today. He expects inflation to remain at 2.8% through next year, suggesting more aggressive action by the Fed. He proposes to start winding down the central bank’s balance sheet as soon as net asset purchases end, while arguing already in favour of 2 rate hikes in 2022. Apart from the inflation overshoot, he points to the health of the US economy – already back at pre-pandemic levels – which allows for a much faster normalization process compared to the previous cycle.
US Treasury Secretary Yellen warned in a letter to congressional leaders that the Treasury is likely to exhaust its extraordinary measures if Congress has not acted to raise or suspend the debt limit by October 18. At that point, the Treasury would be left with very limited resources that would be depleted quickly. It is uncertain whether they would continue to meet all the nation’s commitments after that date. Yellen’s warning comes after a bill to suspend the limit and provide the government from short term funding failed to pass through US Senate with Republicans holding their view that Democrats should bypass the 60-seat required Senate majority. Republicans don’t want to be associated by President Biden’s spending plans, while Democrats urge them to take responsibility for historical debts.
