Sunset Market Commentary

Markets

In the absence of any EMU data with market moving potential, the UK enjoyed the prerogative to set the tone at the start of trading this morning. After four consecutive (mostly substantial) upward surprises, UK June CPI inflation finally came out slightly softer than expected. Headline inflation slowed from 0.7% M/M and 8.7% Y/Y in May to 0.1% M/M and 7.9% Y/Y (8.2% expected). Core CPI also decelerated from a three-decade top of 7.1% Y/Y to 6.9%. Goods prices declined 0.2% M/M causing the Y/Y measure to ease to 8.5% (from 9.7%). Services inflation ‘slowed’ from 0.8% M/M to 0.5% M/M. However at 7.2%, the Y/Y measure is still holding near last months’ cycle top (7.4%). So, there is still work to do for the Bank of England to bring (underlying) inflation sustainably to the 2.0% target. However, in line with recent dovish markets’ reaction function, UK bonds show a clear sign of relief, if not euphoria. UK yields decline between 18 bps (2-y) and 15 bps (30-y). Early this morning the UK 2-y yield at some point almost ceded 25 bps. Money markets scaled back expectations on an August 50 bps BoE rate hike and now see a 50/50 chance between a 25 or 50 bps step. After multiple upside surprises and a clear credibility issue for Bailey and co, we would find it very strange for the Bank of England to forgo the chance to again become a bit ahead of the curve (or should we say be less behind the curve). Markets now see the BoE policy peak rate near 5.75%, down from 6.0%+ levels yesterday and near 6.50% about two weeks ago. In FX markets, sterling traders clearly feel the risk of the BoE ‘prematurely’ slowing its anti-inflation campaign. Sterling tumbled both against the euro and the dollar. EUR/GBP cleared the 0.8658 end June top to currently trade near 0.8685. Cable tumbled a full 1 big figure from the 1.3030 area before the CPI release to 1.2910 currently.

The UK bond rally also supported a bid for core European bonds after yesterday jump higher post (perceived) soft comments from ECB’s Knot. German yields initially declined up to 5.0 bps for maturities less than 10 y but bond gains gradually evaporated. The 2-y German yield currently declines 2 bps (2-y). The 30-y adds 1.0 bp. With markets now discounting a below 4.0% ECB peak cycle rate, there is not that much room to push for an even softer positioning going into next week’s ECB policy meeting. ECB Chair Lagarde for sure will keep the option open for further steps in September (and/or beyond). US Treasuries slightly outperform Bunds ceding between 4.0 bps (2-y) and 2 bps (30-y). The move was supported by softer than expected US housing starts/building permits. UK stocks trade with nice gains  (FTSE 100 + 1.5%). European and US equities trade marginally higher. In FX, sterling sell-off briefly pushed EUR/USD for a test of the 1.12 area, but the pair soon returned into a 1.1200/1.124 ST consolidation pattern. After an impressive rally earlier this month, fortunes again changed for the yen. Comments from BoJ’s Ueda that the bank will keep an easy policy unless the view on the price goal changes, eased speculation on policy change next week. USD/JPY rebounded back to just below the 140 big figure (currently 139.50).

News & Views

South African inflation came in at 0.2% m/m in June, allowing the yearly figure to slow from 6.3% to 5.4%. Transport prices fell 0.9% m/m while food price inflation seems to have lost the sharpest edges (0.5% m/m). Core inflation excluding food, non-alcoholic drinks, fuel and electricity rose 0.4% m/m to be 5% higher compared to the same month last year. The decline here is less outspoken though, easing a mere 0.2 ppts from the May reading. Housing was an important factor keeping core inflation elevated (0.8% m/m). That said, both price gauges are now within the central bank’s 3-6% target range for the first time in 14 months. Today’s numbers also missed expectations by the tiniest margin, prompting markets to doubt whether the South African central bank will deliver another 25 bps hike to 8.5% at its policy meeting tomorrow. The SARB’s governor and deputy governor earlier this month said tightening won’t stop until the MPC is confident inflation will return to the midpoint of the target range. South African swap yields lose a few bps at the front end of the curve. USD/ZAR rises a tad to 17.93.