The trading week started and ended with fireworks from the Bank of England. Governor Bailey’s comments to act against inflation sparked a hawkish repositioning across the aisle with core bonds – from UK Gilts over German Bunds to US Treasuries – selling off for most of the week. The move ended this morning following BoE Chief Economist Pill’s maiden-interview with the FT. He aligns with his boss that action is required, but pushes back against too aggressive market expectations. It’s a yes with regards to ending unprecedented policy support (QE; 0.1% policy rate), but a no when it comes to substantial rate hikes beyond the pre-Covid level (0.75%). In Pill’s opinion, part of the inflation spike remains temporary in nature with wages for example still lagging behind. UK yields fall by 0.5 bps (5-yr) to 3.2 bps (30-yr). The US yield curve bull flattens with yields shedding 0.3 bps (2-yr) to 3.9 bps (30-yr). German yield changes range between –1 bp (30-yr) and +1.2 bps (5-yr). Today’s moves are clearly contributable to a lower real yield which more than offsets a further rise in inflation expectations. The UK 10-yr inflation swap surges to 4.44%, the US gauge stands at 2.86% and the European one at 2.18%. All of these are multi-year highs. The EMU 5y5y forward inflation swap, another market gauge of inflation expectations, hits the ECB’s 2% inflation target. Back in September, ECB Lagarde at her press conference rebuffed a question about a 50 bps rise in this gauge (to 1.75%). “We we do look at the 5-year-5-year, but it’s not the only one, I can assure you.” We look forward to her answer next week if confronted by the fresh 25 bps leap higher. Eco data continue to contribute to runaway inflation expectations. Today’s EMU PMI’s are a point in case. The October composite declined from 56.2 to 54.3 with the move mainly due to a weaker services PMI (54.7 from 56.4). The manufacturing gauge stabilized at 58.5. Details proved again more interesting than the headline numbers though. IHS Markit chief business economist Williamson sums it up perfectly: “The ongoing pandemic means supply chain delays remain a major concern, constraining production and driving prices ever higher. Average selling prices for goods and services are rising at a rate unprecedented in over two decades, which will inevitably feed through to higher consumer prices in the coming months.” EUR/USD remains below 1.1664 resistance and will probably remain in the defensive ahead of the ECB.
The Russian central bank surprised with a bigger-than-expected rate hike from 6.75% to 7.50% (vs 7% consensus). It did so because inflation continues to run substantially hotter than both the BoR’s July forecast and its 4% target. The contribution of persistent factors to inflation remains considerable, the central bank said referring to demand growing faster relative to output expansion capacity. It also warned for cost push inflation coming from structural staff shortages which could cause productivity growth to considerably lag wage growth. Together with inflation expectations of households and businesses rising further to multi-year highs, the balance of risks is “markedly tilted to the upside”. The Bank of Russia therefore keeps the door wide open for further rate increases at upcoming meetings. This should help reduce inflation in the central bank’s baseline scenario from 7.4-7.9% in 2021 to 4-4.5% next year to stay close to 4% further on. Growth is seen at 4-4.5% this year, followed by 2-3% per annum in 2022-2024. EUR/RUB dived below 82 for the first time since July 2020. USD/RUB tested the 70 big figure.
The rout in the Brazilian real continues today. The currency plunged yesterday from USD/BRL 5.6 to 5.66 and is currently headed for the 5.7 mark, the weakest level since April. Investors are worried that president Jair Bolsonaro might bypass a constitutional cap on public expenditures to expand a cash transfer programme for Brasil’s poorest families. Brasil holds general elections in October next year but Bolsonaro’s popularity has waned over his handling of the pandemic. Circumventing the fiscal rule that keeps budget increases in line with inflation creates an important precedent and would surely alarm markets who are already concerned about a lack of fiscal discipline.