Markets
Another incredible bull flattening wave rolled over on core bonds, from the EU over the UK to the US. The decline was both driven by easing (LT) real yields and inflation expectations. This may mean markets have come to fully realize monetary tightening is on the way, not only by tapering QE but also by raising rates much sooner than expected. The latter may explain the underperformance at the short end of the yield curve while expectations for declining growth overwhelmingly dominated the back end. Yields eventually changed +1.6 bps (3y) to -9 bps (30y) in the US. German yield changes varied from +1.8 bps (2y) over -6.1 bps (10y) to -8.9 bps (30y). The bond rally doubled down in the UK, where yields tanked a stunning 12-18 bps at the longer tenors. Sentiment in risky assets (equity, commodities) was weak but that didn’t help the dollar much. EUR/USD finished nearly unchanged near the 1.16 handle. The yen did well but could have done better given the size of the yield declines. Sterling felt the decline of UK Gilt yields but a still-unimpressive euro capped gains in EUR/GBP (finished at 0.844 from 0.842).
Central bank news dominates the Asian session. The BoJ kept the main policy rate unchanged at -0.1% and the 10y yield target at 0%. It slashed growth for this fiscal year (ending in March) to 3.4% (-0.4ppt) to reflect setbacks from a Covid surge during the summer and supply chain issues. Growth in FY+1 was seen at 2.9% and 1.3% for the next. Inflation was cut to 0% this FY and at an unchanged 0.9% and 1% in the following years. JPY strengthens marginally. The massive bond sell-off in Australia after yesterday’s core CPI continues this morning. The RBA refrained from ramping up April 2024 bond buying. The yield on that reference bond for the RBA’s 3y yield target (0.10%) sears 33 bps! The Aussie dollar loses slightly, probably as commodities (oil) decline further this morning. The USD is trading mixed while core bond yields seek to recover a tiny bit of the lost ground yesterday.
The eco calendar is jam-packed today. Growth (Q3) and September PCE inflation is due in the US. We had a glimpse of the latter with CPI figures earlier this month while the former, in a context of markets pondering growth effects of monetary normalization, may be discarded as outdated. In this respect, the ECB meeting may draw most attention even though it is an intermediate one. We’re keen on Lagarde’s reaction to soaring inflation expectations: the ECB’s favourite 5y5y forward gauge trades >2%, highest since 2014. This has triggered quite some repositioning in EU money markets who see a rate hike liftoff occurring already next year. It’s very likely Lagarde will push back against such bets, labelling them as premature since inflation is temporary anyway. While bad for real rates, it may spur inflation expectations even further, thus capping the net damage for European bond yields. This won’t benefit EUR/USD. Downside risks remain with 1.153 as a first reference. Regarding PEPP, we expect to know little more from today’s meeting. Lagarde will deflect any question saying it will be discussed at the December meeting.
News headlines
The Bank of Canada kept is policy rate unchanged at 0.5%. At the same, robust economic growth allows the BoC to end its QE net bond buying program. The BoE expects growth of 5.0% this year, moderating to 4.25% and 3.75% in 2022 and 2023 respectively. The economy also saw strong employment gains in recent months. The current increase in inflation was anticipated, but forces pushing up prices appear to be stronger and more persistent than expected. The Bank now expects economic slack to be absorbed by the middle quarters of next year, sooner than earlier indicated. In this context, interest rates can be raised sometime between April and September. USD/CAD spiked from the 1.2430 area to the low 1.23 area on the hawkish twist but market sentiment later eroded loonie gains.
The Bank of Brasil yesterday raised its Selic policy rate by 150 bps to 7.75%. The move was bigger than expected, following three consecutive rate hikes of 100 bps. The Bank indicated that another similar rate hike will probably come in December. Amongst other factors, it cited that “Recent questioning regarding the fiscal framework increased the risk of deanchoring inflation expectations”. President Bolsonaro recently announced big plans to boost spending ahead of next year’s election.
