Markets
- French central bank governor Moulin argued in an FT interview that France has to remain master of its own destiny. He called on politicians to pass a budget this year to reduce spending and narrow the deficit to reassure markets on fiscal consolidation. He stressed that France isn’t Greece during the Eurozone crisis, but that there is a risk of being gradually strangled by rising interest rates if it doesn’t act. Moulin didn’t want to bring the ECB into the debate as the safety net lies closer to home by repairing public finances. In a side-step to monetary policy, he joined the rising chorus of central bankers (both in Europe and in the US) who argue that the rise in long-term interest rates, tighter financial conditions and the second energy shock may weigh on demand and reduce the need for further action by central banks. Moulin’s German counterpart, Bundesbank Nagel, added though that while uncertainty calls for flexibility, that doesn’t mean it calls for inaction. Chief economist Lane also sticks with the measured approach to control inflation as the ECB faces the second wave of the energy shock with a more resilient EMU economy.
- The OAT sell-off, which resulted in a 146 bps intraday 10-yr swap spread high last Friday, took a breather yesterday. The spread narrowed from levels around 135 bps at the start of trading towards 127 at the end of the session. While investors scrutinize the budget process, we’ll find out how much further the repricing of French credit risk has to go. Swift political consensus across the aisle to avoid last year’s budget crisis is in the government’s and markets’ interest. That wouldn’t put all uncertainty aside though, with giant event risk looming in the form of next year’s presidential elections. The euro’s correlation with OAT’s had been very high the past couple of sessions so the single currency also had some space to recoup. EUR/USD reached a sell-off low at 1.1161 yesterday to eventually close near 1.1215. At the moment there’s little room for a broad recovery as the dollar remains strong overall, enjoying relative interest rate backing as well. The US yield curve steepened yesterday with daily changes varying from -1.4 bps (2-yr) to +4.3 bps (30-yr). The EUR swap curve steepened as well but with the short end dropping 6.7 bps (2-yr) and the long end being up 2.7 bps (30-yr). Data wise, the US September services ISM was strong but came in close to expectations. The headline printed at 54.9, slightly lower than August’s 55.4 but virtually spot on the 55 expected. Details were strong with new orders rising at a rapid pace (59.8) and the employment subindex (narrowly) making it back above 50 for the first time since June. Price pressures build. The index rises further to its highest level since July 2022. While money markets are scaling down October ECB rate hike bets towards zero, they keep the narrative alive with regards to the Fed (25% probability). Today’s eco calendar is thin, centering around ECB & Fed speakers. The US treasury starts its mid-month refinancing operation with a $58bn 3-yr Note auction, but market focus will be on investor appetite for tomorrow’s 10-yr Note sale and Thursday’s 30-yr Bond auction.
News & Views
- US president Trump yesterday in an executive order eased the limits imposed on the use of red diesel. This type of gasoil is typically reserved for off-road usage on farms and construction sites and is exempt from the federal diesel tax, which amounts to 24 cents a gallon. Diesel prices in the US (and elsewhere) have hit record highs in recent weeks amid growing shortages due to refinery outages. Trump in recent weeks also considered a potential export ban, amongst others to the EU. But he backtracked on that idea after the likes of Germany and France on Friday agreed to release some 100 mln barrels of strategic oil and diesel reserves.
- Former ECB board member Bini Smaghi in an op-ed with the Financial Times called on the central bank to put QT on hold. He said the shadows of the 2011-2012 crisis are emerging again, putting upward pressure on long-term bond yields everywhere but in core countries. For Bini Smaghi, winding down the balance sheet with the view of going “back to normal” after the expansion over the previous decade is difficult to understand in the current stress. There is nothing inherently “normal” about the size of a central bank’s balance sheet given that underlying economic and market conditions fundamentally change over time. QT puts upward pressure on yields while the transition and its effects remain uncertain and under-assessed. Bini Smaghi concluded that with inflation being the primary concern, short-term interest rates are the main tool while the principle of prudence suggests putting QT on hold.
