After Recent Sharp Decline in Yields, Market Dynamics Might Gradually Change a Bit

Markets

The ECB and the Bank of England yesterday as expected left their policy rates unchanged at respectively 4% and 5.25%. Contrary to the Fed they didn’t ratify aggressive rate cut bets yet. In its new staff projections, the ECB downwardly revised its path inflation for this year (5.4% from 5.6%) and next year (2.7% from 3.2), but it will still take time to bring inflation back to the 2% target (2.1% in 2025; 1.9% in 2026). At the press conference, ECB Chair Lagarde warned that it absolutely wasn’t the time yet to lower the guard on Inflation. Amongst others, the central bank remains concerned on the inflationary impact of wage rises going forward. In this context, there is no ground to talk about rate cuts yet. The ECB also decided to start reducing the PEPP portfolio by €7.5bn/month in H2. It will stop reinvestments at the end of 2024. European yields set intraday lows during the morning session after the dovish Fed U-turn on Wednesday but gradually regained some ground after the ECB decision and press conference. German yields still declined between 10 bps (2-y) and 1.9 bps (30-y). US yields saw further follow-through declines as the Fed openly prepares for 2024 interest rate cuts. Remarkably, bonds with longer maturities outperformed. US yields declined between 3.8 bps (2-y) and 14 bps (30-y). US November retail sales (control group +0.4% M/M) and weekly jobless claims (declining to a low 202k) suggest ongoing economic resilience. Understandably, the data had limited impact. The prospect of Fed easing next year further supported equites with several US and European indices nearing or touching post-Corona top levels. ‘Policy divergence ‘ between the Fed and the likes of the ECB and the BoE kept the dollar in the defensive. EUR/USD tested the 1.10 area, but a break of the 1.1017 end November top didn’t occur yet. At the BoE decision, 3 members of the 9-member MPC still voted for an additional rate hike and the BoE reconfirmed the need to stay restrictive for and extend period of time. Gilts underperformed (2-y -1.9 bps). Sterling gained against the dollar. EUR/GBP whipsawed around the 0.86 big figure (close 0.8611).

Market focus today turns to the preliminary December PMI’s. The US composite PMI is expected to ease slightly from 50.7 to 50.5. The EMU measure is seen improving slightly from 47.6 to 48, but both manufacturing (44.6) and services (49) are expected to stay in contraction territory. After the recent sharp decline in yields, market dynamics might gradually change a bit. Outright weak data could confirm the downtrend in yield. However, (activity) data in line or better than expected might slow the market push for early rate cuts. On FX markets, the dollar is fighting an uphill battle. A break of EUR/USD above the 1.1017 end November top brings the YTD top of 1.1276 on the radar.

News headlines

China’s PBOC offered a record CNY 800bn of one-year loans to commercial lenders today. Combined with the amount to roll-over expiring loans, the amount injected (CNY 1450bn) was the biggest since 2016. Cash injections are often seen as an alternative to the central bank’s reserve requirement ratio to stimulate the struggling economy. While economic data this morning showed industrial production recovering a bit more than expected, retail sales & fixed asset investments underwhelmed while the property (both investment and sales) drag remains substantial. China seeks to keep liquidity ample after the country in a rare move raised the fiscal deficit ratio to a 30-year high in October and allowed the government to sell an additional CNY 1000bn of sovereign bonds within the year. The yuan recovered from opening losses in the meantime, trading close to the USD/CNY 7.10 key support.