HomeContributorsFundamental AnalysisMarkets Want Hard Evidence of a Slowdown in Inflation Dynamics

Markets Want Hard Evidence of a Slowdown in Inflation Dynamics


Yesterday, the ECB turned a page. With new staff projections forecasting both core and headline inflation to stay above the 2.0% target over the bank’s policy horizon, the ECB couldn’t but formally give the highest priority to address the inflation challenge, even as growth was downwardly revised for this and next year. APP asset purchases will end in July, opening the door for a 25 bps lift-off rate hike in July. However, the ECB’s anti-inflation commitment goes further. If the inflation outlook persists or deteriorates, a bigger hike will be appropriate at the September meeting. After September, the ECB expects that a further gradual but sustained path of rate hikes will be needed. Even as decisions will be data dependent, this looks like quite a strong ‘precommitment’. EMU yields recently already anticipated the start of ECB policy normalization. Still, the prospect of one (and potentially more) 50 bps hikes forced a new break higher. The German curve bear flattened with yields rising between 13.4 bps (2-y) and 3.4 bps (30-y). European swap rates set new cycle highs across the curve. US yields rises were more modest. The belly of the curve underperformed (5-y +6.3 bps). Even so, the 2-y (2.83%) and 5-y (3.05%) are also testing cycle top levels. The change in the ECB inflation narrative didn’t help the euro, on the contrary. A new sharp risk-off correction favored the dollar. The DXY index regained the 102.73 resistance (close 103.22). EUR/USD (close 1.0617) is at risk of falling back below the 1.0627/42 support. US equities lost between 1.94% (Dow) and 2.75% (Nasdaq). The EuroStoxx 50 ceded 1.70%. Intra-EMU spreads versus Germany widened (10-y Italy + 15 bps) even as the ECB signaled to adjust PEPP reinvestments in a flexible manner to avoid market fragmentation.This morning, losses on Asian equity markets (about 1.0% on average) are more modest compared the US and Europa yesterday. Even so sentiment remains fragile. Later today, the focus turns to US May inflation. Headline CPI is expected at 0.7% M/M and 8.3% Y/Y (was 8.3 in April). Core is seen at 0.5% M/M and 5.9% Y/Y (was 6.2%). Yesterday’s price action suggests that markets want hard evidence of a slowdown in the (monthly) inflation dynamics. If not, expectations for the Fed to keep a pace of 50 bps rate hikes in September (or even beyond) might be reinforced. This might push 2 & 5-yields to new cycle highs. The top in the 10-y yield (3.20%) is further away but also comes on the radar. Inflation moderating too slowly also might support further dollar gains both via higher yields and a further risk-off. EUR/USD falling below the 1.06 area, suggests further losses in the 1.0341/1.0806 trading range. This morning, the yen regains modest ground (USD/JPY 133.74) on headlines of a meeting between the Japanese Ministry of Finance and the BOJ. However, in case of higher US yields, a test of the 135.15 multi-year top might still occur, unless there comes decisive action from Japanese authorities.

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Chinese inflation fell 0.2% m/m in May to stabilize at 2.1% y/y, the National Bureau of Statistics revealed. A slight rise to 2.2% was expected. The first monthly decline of 2022 came as Chinese consumers’ spending and sentiment was dampened by Covid restrictions. Food and energy remain two key price drivers in the yearly figure. Excluding both, inflation only rose by 0.9% y/y. Factory gate inflation eased further from 8% y/y to 6.4% y/y, the slowest pace since March 2021. Prices of mining and raw materials maintained double digit y/y gains though. Unchanged (core) CPI and the ongoing slowdown in PPI may ease policymaker’s concerns about inflation and could allow them to focus more on how to support growth. The Chinese yuan trades unchanged just south of USD/CNY 6.70.

The Turkish central bank doubled the recently introduced reserve requirement ratio for lira-denominated commercial cash loans to 20%. In the same statement published this morning, the CBRT also instructed banks to hold more lira securities for foreign currency deposits as it seeks to increase the weight of local currency assets in the collateral pool. “The aim of this regulation is to increase the effectiveness of the monetary policy within the scope of the liraization strategy.”, the CBRT explained. The Turkish lira is not impressed, losing further ground this morning to EUR/TRY 18.37. The currency since May came under pressure again after weeks of relative stability. President Erdogan over the past few days poured oil to the fire by again pressing for further rate cuts.
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