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Current Yield Correction Could Go On


The US manufacturing ISM surprised to the downside yesterday, easing from 52.8 to 50.9. The lowest reading since May 2020 followed a (deeper) drop in employment and new (export) orders into contraction territory. Backlogs fell sharply from 53 to 50.9. It reinforced the ongoing core bond yield correction earlier on the day, especially in the US. American rates tumbled 20 bps, give or take, at the belly of the curve (5-10y) on the account of real yields. The short end eased 16.5 bps as markets eased bets on Fed policy tightening even as most Fed governors (e.g. Williams) continue to argue for the opposite. German yields shed between 13.9 bps (2y) to >19 bps (5y, 10y). Gilt yields in the UK tanked in similar fashion with the exception of the very long end (30y +6.3 bps) after Chancellor Kwarteng cancelled the planned scrapping of the top tax rate. He later bit the dust again at the Conservative Party Conference. He announced that he’ll present his medium-term fiscal plan – containing a five year debt-cutting trajectory aimed to reassure markets – “shortly”. The Financial Times citing sources reported this could be as soon as this month instead of the original November 23. Equity markets rallied yesterday. European stocks undid losses of 2.5% to finish 0.7% higher. Wall Street rose between 2.3 and 2.7%. The dollar was under pressure. DXY closed below 112. EUR/USD, despite an unconvincing euro, rebounded intraday from 0.975 to 0.983. EUR/GBP stumbled below 0.8721 support to 0.868. Commodity currencies profited from an imminent OPEC+ output cut.

Asian-Pacific trading is all about the RBA decision (see below). It simply adds to the march higher in core bonds which is supporting stock markets. Gains go as high as 3.3% in Japan. The Aussie dollar obviously underperforms on FX markets. The dollar together with the euro strengthens a tad. USD/JPY is not leaving the 145 station as markets continue to challenge the Japanese MoF. Sterling holds on to yesterday’s gains.

With an empty economic calendar ahead for the day we think the current yield correction could go on. Things were priced to perfection and there’s scope for yields to consolidate further. In Germany, the 10y hit a first technical support at 1.92% yesterday. The next reference stands at 1.77%. For the European 10y swap and the US10y sovereign yield we keep a close eye at 2.72% and the 3.46%/3.50% area. The dollar is in for a temporary break as well, assuming Treasury outperformance combined with a more constructive setting for equities (but watch out for sucker rally’s). EUR/USD 0.99(5) is the first important technical reference. UK politics these days are worth following up too. Some cabinet ministers say Truss’s economic revolution plan may be over already. To be continued.

News Headlines

The Reserve bank of Australia surprised as it raised its policy rate by only 25 bps to 2.60%, while a 50 bps hike was largely expected. The RBA reiterates it commitment to returning inflation to the 2-3% target and further interest rate hikes are likely. However, the RBA is assessing the outlook on inflation and growth as rates have been increased substantially in a short period of time. Inflation is still too high and might further increase in the months ahead but is expected to ease next year. The RBA sees inflation a little above 4% next year and around 3% over 2024. The RBA mentions the global outlook as a source of uncertainty. It is also uncertain how Australian households will respond to tighter financial conditions including the effect on mortgage payments, with consumer confidence and housing prices declining. Further rate increases will be data dependent. Australian government bond yields currently are declining between 34 bps (3-y) and 20bps (10-y). The Aussie dollar initially dropped from AUD/USD 0.6510 to 0.6451, but reversed part of the initial decline (currently 0.648).

The BoE yesterday only bought £22mln of Gilts under the program it initiated last week to address instability in the bond market. The maximum amount of daily purchases was set at £5bln. Over the four days since the start of the program, the BoE bought a communicative £3.66 bln compared to the potential maximum of £20 bln. The small amount of buying might be an indication that the BoE sees market strain easing. The Bank probably also avoids too much interference of current buying with its overall policy stance. The program is scheduled to last till 14 October.

KBC Bank
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This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.

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