Markets
Global bond markets are closing the week with some more gains. The common factor underpinning the move is hope on progress in the US-Iranian talks. The water is still deep on certain matters, particularly on the enriched uranium stockpile, but markets consider it a lower hurdle than the one for renewed escalation. Oil prices turned lower from as high as $112 on Monday to around $103, offering support to bonds. UK gilts outperformed US and European peers with weekly yield declines mounting to 23-29 bps. A set of unconvincing economic data – spanning retail sales, PMIs, consumer confidence and the labour market report – depressed BoE hiking bets. Governor Bailey and others before parliament have doused speculation somewhat too this week by saying markets have done the tightening job for them. They prefer to wait before actually pulling the trigger. The budgetary theme meanwhile, and with it risk premia, ebbed away again. It helped that the top contender in a potential challenge to prime minister Starmer, Andy Durnham, recently said he would keep the current set of fiscal rules. Bund yields dropped between 11 and 14.5 bps across the curve. ECB President Lagarde stuck to the non-committal script when speaking at the Eurogroup today, adding that she wasn’t going to give “much indication” on what could happen at the June meeting. US Treasury yields had to settle for about half of that. We were looking for the 10-yr yield to close the week above the upper bound of a 2023-2026 closing triangle (4.57%), which would have paved the way for a return to the 2023 high of 5%. That didn’t happen so far, offering Kevin Warsh some respite amidst his swearing-in scheduled today as the new Fed chair. Warsh in the past has criticized the Fed’s swollen balance sheet but his aim of shrinking it comes of course with implications for already elevated (long-term) bond yields. Warsh more generally promised a regime change at the Fed which next to winding down the balance sheet includes establishing a new framework for analyzing inflation and alter central bank communication (eg. less press conferences). Stock markets had a good run this week too, with gains for the EuroStoxx50 (+1% today) mounting to 3.4%. A mid-week rebound in US indices keep the previous record highs of early-May close. The stoic performance of currency markets stands out. EUR/USD hovered all week around but mostly above 1.16, DXY did the same around 99 and USD/JPY around 159. EUR/GBP slid from 0.875 levels earlier this week to 0.864 today. With the UK considered even more vulnerable to the energy price shock, the pound clearly outperforms against the euro when worries subside somewhat.
News & Views
Germany’s May IFO business climate painted a slightly more benign picture of the economy compared to yesterday’s PMI. Sentiment among companies recovered slightly following the slump in March and April, improving from 84.5 to 84.9. Companies assessed the current business situation somewhat more favorable (86.1 from 85.4) . Expectations for the coming months are also less pessimistic (index 83.8 from 83.5). Ifo assessed that the German economy is stabilizing even as the situation remains fragile. On a sector base, manufacturing and trade improved. Manufacturing companies turned more positive on the current situation, but expectations declined as orders continued to fall. Sentiment in the services sector even improved considerably especially as expectations recovered following a decline in the previous months. In construction, the business climate fell slightly.
As the is the case for several areas in FX of late, the realized volatility of the Czech koruna (against the euro) recently was very low, despite multiple sources of geopolitical turbulence. KBC Economics sees this move as being supported by strongly improved macro fundamentals of the Czech economy including, low inflation, solid GDP growth and a solid external position. The koruna continues to benefit from an attractive interest rate differential relative to the euro. CNB’s high foreign exchange reserves also are a strong stabilizing factor. Aside from macro fundamentals, the mechanics of the koruna market, particularly the way domestic exporters and importers hedge their exposure, have changed the mechanics of the koruna FX market. Instead of simple forwards, there has been a growing trend toward hedging using option structures, often linked to a specific exchange rate band, which drains volatility from the market. This regime holds for now, but if barriers are breached, hedging products may, on the contrary, temporarily amplify volatility.
