The bond market sell-off took breather yesterday. There were no important data with investors counting down to today’s key US CPI release. Central bankers’ comments were plenty but didn’t alter the market assessment in any profound way. Fed members Bostic and Mester were on a same line, supporting a March rate hike. A 50 bps step isn’t excluded, but for now they favour a gradual approach of 25 bps at subsequent meetings. There is also a growing consensus to start the balance sheet roll-off soon and at a rather swift pace. US yields initially dropped 3-4 bps, but especially the short end soon rebounded. Investors apparently didn’t want to be wrongfooted by today’s expected multi-year high inflation. The US 2y yield still closed at a 1.36% cycle top. The longer end fared better, supported by strong investor interest at the Treasury’s $37bn 10y bond sale. At the close, the US curve again returned to a modest flattening trend with the 2y rising 2.3 bps and the 10y easing 2.3 bps. This time the real yield also eased mostly. The European yield correction had some more traction. German yields eased 5-6 bps for in the 2/10y sector. The very long end underperformed (-2.8 bps for the 30y). Equity investors embraced the calm on the bond markets. The EuroStoxx 50 gained 1.8%. US indices rose between 0.86% (Dow) and 2.08% (Nasdaq). Slightly USD supportive interest rate differentials combined with a positive risk sentiment kept the trade weighted dollar (DXY) more or less in balance (95.55). EUR/USD tried to move higher in the lower half of the 1.14 big figure, but the move had no strong legs (close 1.1425). Sterling underperformed with EUR/GBP rebounding from the 0.8415 area to close near 0.8441. BoE’s Chief economist Pill confirmed a further hiking cycle but also advocated a gradual pace.
Focus turns to the US January CPI release today. Headline inflation is expected at 0.4% M/M and 7.2% Y/Y, which would be the highest reading since 1982. Core inflation might accelerate to 5.9% Y/Y from 5.5%. The pace, especially M/M dynamics, will determine whether the Fed should consider a 50 bps hike. Yesterday’s late session rise in ST yields suggests that markets are positioned for a high figure. So there could be some further ST consolidation after the recent yield rise. If so, the room for a substantial yield correction stays limited. European yields yesterday eased off recent peak levels. Also here, we expect the 0.10% level for the German 10y and the 0.60% for the 10y swap to offer solid support. EUR/USD currently stabilizes in a tight 1.1395/1.1485 consolidation range. If US inflation doesn’t surprise on the upside, a retest of 1.1485 is possible. For sterling, quite some BoE tightening is already discounted. Some further sterling underperformance, both against the euro and the dollar might be on the cards. Also keep an eye at the Riksbank policy meeting. Will this ‘last man standing’ finally also leave ‘team temporary’?
Speaking before the Chamber of Commerce, Bank of Canada governor Macklem said the central bank won’t be on “autopilot” when it starts raising interest rates, most likely in March. He hinted that much will depend on business investment, noting that all else being equal, the less investment there is (because of inflation uncertainty), the higher rates will have to be. According to the governor, the current strong price growth (4.8% Y/Y in December) is not “the result of generalized excess demand” but mostly a supply issue. Productivity growth is essential to have non-inflationary growth, he added. Macklem said interest rates may even have to rise above the neutral rate around 2.25%. The Canadian dollar marginally strengthened to USD/CAD 1.267.
The central bank of India left the repo rate unchanged at 4%. The reverse repo remains steady at 3.35%, defying expectations of a hike to 3.55% which would have indicated a tighter policy stance to mop up excess liquidity. Indian inflation came in at 5.59%, above the 4% mid-point target, but the central bank chooses to help growth recover from the omicron hit. Governor Das said this will allow India to grow at the fastest pace among major economies. GDP growth is projected at 7.8% for the next fiscal year 2022-2023 after growing 9.2% this FY. Inflation is forecasted to ease from 5.3% this FY to 4.5%. The Indian rupee briefly went north of USD/INR 75 before paring losses to 74.93.