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We’ve stressed on multiple occasions that any correction higher in the core bond sell-off remain fairly limited both in terms of magnitude and in terms of length. Yesterday’s trading session confirmed this once more and highlights the strength on the underlying market dynamic this year. Don’t get blindsided, it’s all about inflation and changing reaction functions of central banks. Core bonds returned to full sell-off mode following a brief move higher around quarter-end with new sanctions against Russia following war crimes adding some doubt. Yesterday’s decline started during European trading hours, but accelerated during US dealings. US Treasuries underperformed German Bunds in the process.

A strong US services ISM (58.3 from 56.5) kickstarted the process. Details showed a strong rebound in employment (54 from 48.5) and big boost in new regular and export orders (both >60). Business activity stabilized at a good 55.5 with inventories crashing from 55.3 to 40.2. Price pressure remains elevated.

Shortly after the release, Washington-based heavy-weight Fed governor Brainard sharpened the knives ahead of tonight’s FOMC Minutes which will reveal details on the pace of the Fed’s balance sheet roll-off. Brainard said that a rapid reduction will start in May. General expectations are a monthly wind-down of $100bn or more. This includes both US Treasuries and mortgage-backed securities. Brainard added that she’s prepared to take stronger action in the tightening cycle if needed, in a nod to 50bps rate hikes from May onwards, as “it is of paramount importance to bring inflation down”. She focused on rising inequality in her argumentation with inflation especially burdening low- and middle-income families whose pay rises can’t match inflation numbers and eating into disposable income.

Kansas City Fed George and SF Fed Daly sounded the alarm bells on inflation as well: “people hate high inflation”, “inflation is as harmful as not having a job”. They both backed the need to step things up in the tightening cycle. Turning to the market reaction then.

US yields added 9.3 bps to 15.7 bps with the belly of the curve underperforming the wings. The US 10-yr yield set a new recovery high north of 2.6%, taking out 76% retracement (2.56%) on the 2018-2020 yield decline. Full retracement brings us to the 2018 top of 3.26%. European bonds followed US Treasuries south with German yields rising by 6.1 bps (2-yr) to 10.8 bps (10-yr).

EUR/USD suffered from yield dynamics, giving away 1.0961/45 intermediate support to close near 1.09. A test of the previous cycle low at 1.0806 becomes inevitable. The trade-weighted benchmark yesterday broke that reference (previous top at 99.42) and is looking to move beyond the psychological 100-mark for the first time since May 2020. USD/JPY is attacking 124 this morning. The strong sell-off on bond markets spilled to stress on equity markets with main US indices losing 0.8% (Dow) to 2.25% (Nasdaq).

News Headlines

The European Commission triggered its rule of law mechanism for the first time against Hungary yesterday. EC president Von der Leyen said they will send the letter of formal notification before the European Parliament. The decision may ultimately lead to the withholding of some of the €24bn Hungary is to receive up to 2027. Von der Leyen also ruled out a quick disbursement of the €7.2bn funds Budapest applied for under NextGenEU. The EC’s move comes just a few days after PM Orban’s landslide victory to secure a fourth term. It is the culmination of a decade-long spat over the erosion of democratic standards and corruption. The bloc demanded reforms but said it was “not able to find a common ground”. The Hungarian forint lost over 2% against the euro to EUR/HUF 376.62.
 
China’s private Caixin services PMI in March tumbled to the lowest level since February 2020. At 42.0, down from 50.2, the figure printed much lower than consensus (49.7) too. Last month’s steep drop followed China’s worst Covid outbreak since the start of the pandemic. It triggered new harsh lockdowns. New business inflows registering the weakest level since March 2020. The indicator for planned future activity hit a 19-month low. Earlier this week, the manufacturing gauge also fell into contraction territory, from 50.4 to 48.1, bringing the combined composite PMI at 43.9.

Market movers today

FOMC minutes from the March meeting will be released in the evening, and focus will be on any hints about the upcoming QT, more so than rate hikes. Fed's Brainard said yesterday that she expects balance sheet reduction 'at a rapid pace' starting in May.

The National Bank of Poland (NBP) will have a monetary policy meeting, where consensus is looking for a 50bp hike, while markets are pricing in 75bp. There will also be several ECB speakers on the wires throughout the day, including de Guindos, Schnabel and Lane.

Negotiations also continue on the new EU sanctions on Russia, EU yesterday proposed a ban on Russian coal imports and European Commission president Ursula von der Leyen hinted the group is working on an oil import ban as well.

The 60 second overview

Ukraine-Russia: Yesterday we got one of the first indicators of the impact on the Russian economy as the service PMI for March falls to 38.1 from 52.1 in February. The decline in business activity and new orders (both domestic and foreign) explains the setback as firms also cut back on staffing amid weak demand. At the same time, inflation pressures quicken due to higher supplier prices and adverse exchange developments. The composite indicator is now at 37.7 compared with 50 in February and is a signal of a recession of about 3-4%. Looking ahead, further decline in the indices can be anticipated as western supplies are further curtailed over time plus new sanctions being considered, suggesting that the worst has not been seen yet.

Yesterday EU announced that they are set to stop buying Russian coal in the next leg of sanctions, and only ending oil and gas at a later stage (no date horizon set).

Euro area: The euro area final PMI figures released yesterday held up better than anticipated at 54.9 (composite, vs. 54.5 expected) as services PMIs have been supported by the reopening of the economies. However confidence indicators which are a good predictor of PMIs ahead provide a dour expectation. Also in Europe, one of the bigger German wage negotiations this year in the chemical industry has been postponed until October, with the partners agreeing on a one-off payment of EUR 1400 for now. In light of the very high uncertainty, we might see similar trends in other negotiations, but it is a first sign that for unions, job security might matter more than real income growth right now.

EU: EU triggered the 'rule-of-law' clause on Hungary yesterday. This would open up for Hungary not receiving EU funds, including the NGEU funds, where they are otherwise set to receive around EUR40bn.

Equities: Equities were mostly reverting lower on Tuesday. The yield curve steepened, taking growth to an underperformance of value (after beating the tape the last few days). Value outperformed growth by more than 100bp and defensives beat cyclicals. Dow -0.8%, S&P500 -1.3%, Nasdaq -2.3% and Russell 2000 -2.4%.

FI: After the EGB rally on Monday, we saw a significant sell-off yesterday, with massive spread widening. 10y Bunds sold off 11bp while the BTPs-Bund spread still widened 8bp. This came on the back of multiple reasons. PEPP ending not to support the significant supply yesterday from Germany, EU and Austria, better than expected PMIs, and potential of new sanctions ultimately leading to speculation of higher consumer prices. That also means that the continued bid for linkers has continued in general very volatile inflation markets. All of this supports the reason for accelerated tightening from ECB. Currently there are 63bp priced in by year end (€STR). France led the underperformance in the semi-core space as market focus has turned to the first round elections this Friday.

FX: Summary. The time could be now for new lows in EUR/USD. SEK rallied to yesterday.

Credit: Credit markets were in risk-off mode on Tuesday, following some of Europe's major equity indicies. Itraxx main widened 2.6bp to close at 73.1bp, while Xover was 13bp wider, closing the day at 345.2bp. Despite the soft-ish sentiment, primary markets were alive and kicking, with the European Union offering a jumbo sized EUR6bn 20YR green bond. The more than 13x oversubscription indicated healthy investor appetite for the deal, which ended up having a re-offer spread of only +9bp (to mid swaps).

Federal Reserve (Fed) Governor Lael Brainard’s hawkish comments rocked the markets yesterday as she said that the next interest rate hikes should be more aggressive to tame the skyrocketing inflation in the US, and that the Fed could start reducing its near $9 trillion balance sheet as soon as next month, and at ‘a rapid pace’.

Because the market is fully ready for a taper tantrum on the rates front, it’s mostly the comments regarding a potentially aggressive balance sheet reduction that primarily dampened the market mood yesterday, sending the S&P500 some 1.26% down, to below its 100-DMA. Nasdaq sold off 2.26% and closed the session below the 15000 mark.

Both indices start giving toppish signs, and more importantly, the short-end of the US yield curve is rising so steeply that the inversion across the yield curve brings about the worries of an imminent recession in the US.

In this tense environment, investors will be closely watching the Fed minutes today. There would be no surprise if the Fed hinted a 50-bp hike in the next meeting. Activity in Fed funds futures assess more than 75% chance to a 50-bp hike.

Yet, what will really make the difference is the speed at which the Fed will shrink the balance sheet. And there is a big potential for a hawkish pricing on this front.

The market risks remain tilted to the downside given the hawkish shift in Fed officials’ latest comments, the scary inflation figures, combined with abnormally strong jobs reports and higher wages support the idea that if there is a good time for the Fed to hit the brakes on its ultra-lose policy, it is now.

In the FX

Brainard’s comments sent the US dollar rallying yesterday. The dollar index is now preparing to flirt with the 100 offers, the EURUSD sank below the 1.09 level as Cable pulled below the 1.31 mark, but if the Fed minutes doesn’t reveal a further hawkish surprise, we shall see the dollar give back the latest gains and the euro and the pound record a minor rebound.
Baby steps

The US and the Europeans are expected to announce a new round of sanctions on Russia after the atrocities in the cities new Kyiv that have been recently liberated by the Russian troops threw gas on fire. While the US treasury will halt dollar debt payments from Russia to increase the pressure of a default, EU is expected to announce a ban on Russian coal imports. Banning the Russian coal is a baby step in banning the Russian energy, as the Europeans are still not ready to digest the idea of a ban on Russian oil and gas for now, as it would be too hard on the economy.

The reduced risk of a European ban on Russian oil keeps the oil bulls contained. The barrel of US crude consolidates a touch above the $100 mark. Technically, the price is still above the 50-DMA which has not been significantly broken to the downside, hence remains the major support to pull out for a deeper downside correction in oil prices.

Data-wise, the latest API data showed a surprise build in US oil inventories last week by about 1 million barrels. The more official EIA data will give a clearer insight on the US oil inventories, but any positive news (higher inventories) will certainly not be enough to trigger a sustainable negative move in oil prices.

The S&P 500 falls back as yield curve inversion raises concerns of an economic contraction.

On the daily chart, a break above the February high at 4590 and a bullish MA cross suggest a steady market mood. A drop below 4580 prompted leverage buyers to bail out but found support at 4510.

4455 on the 20-day moving average would be the second line of defense in case of a deeper correction. Buyers may see short-term retracements as opportunities to stake in. A bounce above 4600 could be a continuation signal.

The US dollar rallies as traders hoard the safe haven currency. The price is in a narrowing consolidation range as a sign of short-term hesitation.

Overall sentiment remained downbeat after the latest rebound hit resistance at 1.3300. The bulls need to lift offers around 1.3220 before they could turn the tables.

Otherwise, the path of least resistance would be down. 1.3050 is the closest support and the psychological level of 1.3000 is a critical floor. A bearish breakout could make the sterling vulnerable to a new round of sell-off.

The Australian dollar soared after the RBA signaled higher interest rates later this year. The pop above the daily resistance at 0.7550 has put the Aussie on a bullish reversal course for the weeks to come.

Solid green candles indicate a combination of short-covering and momentum buying. Last June’s high at 0.7770 is the next target.

In the meantime, the RSI’s overbought situation led to a brief pause. Trend followers could be looking to join the rally at pullbacks. 0.7470 is fresh support in this case.

Daily Pivots: (S1) 160.72; (P) 161.34; (R1) 162.18; More...

Intraday bias in GBP/JPY remains neutral as consolidation from 164.61 is still extending. Outlook remains bullish with 158.04 resistance turned support intact, and further rally is expected. On the upside, break of 164.61 will resume larger up trend to long term fibonacci level at 167.93. However, firm break of 158.19 will turn bias to the downside and bring deeper pull back.

In the bigger picture, up trend from 123.94 (2020 low) is still in progress, and notable support from 55 week EMA affirms medium term bullishness. Next target is 61.8% retracement of 195.86 (2015 high) to 122.75 (2016 low) at 167.93. Sustained break there will be a long term bullish signal. This will now remain the favored case as long as 150.95 support holds.

Daily Pivots: (S1) 134.35; (P) 134.74; (R1) 135.18; More....

EUR/JPY is still staying in consolidation from 137.49 and intraday bias remains neutral. With 133.70 minor support intact, further rally is expected. On the upside, sustained break of 137.49 resistance will resume larger up trend for 144.06 projection level next. However, firm break of 133.70 will indicate short term topping, and turn bias back to the downside for deeper pull back.

In the bigger picture, up trend from 114.42 (2020 low) is in progress. Sustained break of 137.49 (2018 high) will resume larger pattern from 109.30 (2016 low). Next target will be 100% projection of 114.42 to 134.11 from 124.37 at 144.06. In any case, outlook will now remain bullish as long as 124.37 support holds, in case of deep pull back.

Daily Pivots: (S1) 0.8323; (P) 0.8348; (R1) 0.8369; More...

intraday bias in EUR/GBP remains neutral at this point. on the downside, break of 0.8294 will argue that rebound from 0.8201 has completed at 0.8511, and revive near term bearishness. Intraday bias will be back on the downside for retesting 0.8201 low. On the upside, however, break of 0.8511 will reaffirm that 0.8201 is a medium term bottom, and target 0.8697 medium term fibonacci level next.

In the bigger picture, a medium term bottom should be in place at 0.8201, on bullish convergence condition in daily and weekly MACD. Rise from there could either be a correction to the down trend from 0.9499 (2020 high), or a medium term up trend itself. In either case, further rise should be seen to 38.2% retracement of 0.9499 to 0.8201 at 0.8697. Sustained break there will target 61.8% retracement at 0.9003. This will remain the favored case as long as 0.8294 support holds.

Daily Pivots: (S1) 1.4290; (P) 1.4425; (R1) 1.4529; More...

Intraday bias in EUR/AUD remains on the downside at this point. Current down trend should now target 1.3624 long term support next. On the upside, above 1.4559 minor resistance will turn intraday bias neutral and bring recovery. But outlook will stay bearish as long as 1.4940 resistance holds.

In the bigger picture, fall from 1.9799 is seen as a long term impulsive move. Next target is 61.8% projection of 1.9799 to 1.5250 from 1.6434 at 1.3623, which is close to 1.3624 long term support (2017 low). Some support could be seen there to bring interim rebound. But overall, break of 1.5354 support turned resistance is needed to be the first sign of medium term bottoming. Otherwise, outlook will stay bearish in case of recovery.