Barring a Downside Surprise, Today’s CPI in Any Case Should Support Yields

Markets

Several Fed and ECB speakers hit the wires yesterday and provided some distraction during an otherwise news calm trading session. There’s a divide growing among Fed officials to hike rates further or not. The likes of Chicago Fed president Goolsbee call for “prudence and patience” and first want more data to assess the impact of potentially tighter credit conditions following the collapse of several regional US banks. That’s clearly the minority view though. NY Fed Williams said one more hike as suggested by the dot plot is a “reasonable starting place” but that the actual path depends on incoming data. Kashkari from the Minneapolis Fed sees hopeful signs that calm has returned and said that the central bank has more work to do. Bullard (St Louis), Harker (Philadelphia) and Mester (Cleveland) struck a similar tone and added that rates would have to stay at their peak for some time. ECB’s Villeroy is worried about inflation becoming even more widespread and potentially more persistent. He referred to underlying inflation rising steadily even as headline inflation has topped off. This requires raising rates further, though possibly not as aggressive as before, and in any case keeping them at a high enough level for a sustained period. Core bonds lost ground with German Bunds hugely underperforming USTs yesterday. In a catch-up move with the US after being closed on Friday and Monday, German rates rallied 10.7-15.2 bps with the front underperforming. American yields only added 1.3 bps at the front but that’s hiding an intraday recovery move that went as far as 12 bps. European equity sentiment was especially good. The Euro Stoxx 50 closed at the highest level since begin 2022. With the yield and sentiment advantage, EUR/USD rose to 1.091. That combo is also what weighed the yen down. EUR/JPY extended gains beyond 145 to finish at 145.89. USD/JPY held stable around 133.6. EUR/GBP again used support from the upward sloping trend line to close somewhat higher at 0.8783.

Asian markets show no clear direction going into today’s main event: US CPI. Headline inflation in March is expected to ease from 6% to 5.1% but core inflation could increase from 5.5% to 5.6% on a strong 0.4% m/m pace. An in-line or higher-than-expected outcome should further strengthen the case for a May rate hike by the Fed. Markets currently attach a 75% probability to such a scenario. We doubt it will change their thinking about rate cuts later on though. Current market pricing shows the cutting cycle to begin in September. It will take more strong data points for that to be priced out. Barring a downside surprise, today’s CPI in any case should support yields, especially at the front end of the curve. The $32bn 10y auction tonight might be interesting for the long(er) end. First resistance in the 10y yield is located at 3.50%, followed by 3.64%. UST underperformance vs Bunds may give the dollar some much-needed breathing space. This morning’s move included, the small USD uptick vs the euro over the past few days gets wiped out already. Support for the dollar kicks in at EUR/USD 1.0973/1.1033. USD resistance levels are located around the 1.08 big figure, followed by 1.0735.

News Headlines

Climate think thank Ember published its fourth annual global electricity review. Wind and solar reached a record 12% of global electricity in 2022. We might as well have seen the peak of fossil fuel electricity generation last year which was unexpectedly boosted by the rush for energy security in the wake of the Russian invasion in Ukraine. Wind and solar are set to expand enough that total electricity production from fossil fuels will decline slightly and continue downward through at least 2026, according to the Ember forecasts. The share of fossil fuel electricity generation is set to decline from currently around 60% to slightly over 50% by 2026. The International Energy Agency earlier said that renewable power sources in 2022 helped to meet the vast majority of additional power needs.

Italian PM Meloni yesterday evening unveiled the 2023 budget which included slightly more tax cuts (€3bn) than expected. The budget deficit is set to reach 4.5% of GDP with growth predicted at 1% this year (vs 0.6% previously) and 1.5% in 2024 (vs 1.9%). Critical to next year’s outlook will be receiving EU instalments under the EU Recovery Fund which are at risk of delay over discussions on some of the projects, milestones and targets to be reached.