Wednesday, 3 August 2022
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•          Pelosi’s visit to Taiwan provoking the ire of China dominated most of the European trading session. Risky assets including equities were sold while safe havens enjoyed a good bid in your typical risk-off market reaction. However, even before Pelosi’s plane had yet to land on the self-governing island, planned in early US dealings, the market was already going in reverse again. We know (geo)politics have a short shelf-life as market themes, but this is really something else. Anyway, both European and US yields started bottoming out, and fast. Important technical support zones (eg. in the 10y tenors) served as the launching platform. US Treasuries hugely underperformed Bunds following a string of hawkish Fed speeches. Some of the most eye-catching quotes are: “50 bps at the September meeting is reasonable, but 75 bps could also be okay” (Evans), “That’s [price stability] what we’re about, what we’ve been about this year and will continue to be about until we get inflation under control” (Mester), The Fed is “nowhere near” being almost done in fighting worst inflation in four decades (Daly). The hawkish chorus is going directly against the sharp market repricing in recent weeks and triggered a massive bear flattening. US yield rose between 17.9 and 21.8 bps in the 2y/5y sector while adding 9.3 to 17.3 bps in the 10y/30y segment. German/EMU swap yields had to settle for 5bps+, although after having erased intraday losses that were much larger than in the US. Selling pressures were the biggest at the front end of the curve. Equities looked for a bottom as tensions on markets eased but the move was countered by the sudden rise in core bond yields. European shares dropped 0.6%, losses on WS went as high as 1.23% (DJI). The dollar flourished; first on risk-off, then as (US) yields surged. DXY rebounded of the 105 support to 106.24. EUR/USD slipped below 1.02 again. The yen traded both market episodes textbook-wise. Its initial strengthening move thus reversed abruptly, with USD/JPY leaving intraday lows around 130 for a close at 133.18. EUR/JPY completely erased a sharp drop below 135.
•          The Taiwan trip is still at the center stage during today’s Asian session. Pelosi in a press conference said the US stands by Taiwan and hinted at an imminent trade agreement. Meanwhile, China responded with military drill exercises nearby, has banned imports from and exports to Taiwan of several products and banned dealings with some entities. Unlike yesterday though, stock markets shrug. They print mostly higher, even. USD/CNY eases further to 6.75. It suggests that, barring China announces very aggressive countermeasures, markets look ready to ditch it as a trading theme already. This brings us to the eco calendar for today with the US services ISM as the highlight. The PMI equivalent two weeks ago shocked by dropping below 50 and brings downside risks for the ISM (expected at 53.5 from 55.3). That said, yesterday’s core bond moves suggest that a lot of bad (recession) news has been discounted and we could see more reality checks in coming days (eg. payrolls on Friday). Furthermore, we note that the likes of Mester yesterday indicated willingness to sacrifice growth and that it isn’t a good enough reason to back down on the commitment of bringing down inflation. US (in those in Europe in sympathy) yields’ downside looks a bit better protected now, especially at the front end of the curve. This in turn could also help find a bottom for the dollar after having corrected lower these last weeks. There’s another flurry of Fed speeches scheduled for today as well which are worth following up. We wouldn’t be surprised to see some more verbal interventions.

News Headlines

•          China’s services PMI unexpectedly jumped in July to the highest level since April 2021. Coming in at 55.5 it beat expectations for a decline from 54.5 to 53.9. The sector enjoyed tailwinds from easing Covid restrictions and a return to more normal business conditions. New orders rose at a faster pace, highlighting mainly increased domestic demand. Chinese service companies maintain a relatively cautious approach to staffing level though and backlogs fell. Nevertheless, the 12-month outlook was assessed as being the brightest since November 2021. Combined with the bigger-than-expected drop in the manufacturing gauge published earlier this week, the composite reading stood at 54, down from 55.3 in June.


The ECB ended net asset purchases and lifted rates with a 50 bps inaugural hike. More tightening is underway but the ECB refrained from guiding markets on the size of future rate hikes. Economic indicators however show growth is stalling or even contracting. Markets doubt whether tightening may last in 2023. Germany’s 10-yr yield extended a correction lower. After breaking important support at 1.12% and 1.03%, 0.73% is the next reference.

The Fed hiked to neutral by a back-to-back 75 bps in July. The size of future moves depend on the incoming data. QT will hit max speed by September. But markets begin questioning the Fed’s hawkish intentions following a string of weak data. Yields are under pressure. The 10y dropped below the lower bound (2.70% area) of the sideways trading range. A test of next support at 2.55% was rejected.

The euro zone’s (energy) crisis is being accompanied by an Italian political crisis. Growing recession fears hammered EUR/USD below the 2017 low of 1.0341. Parity was tested before a technical (USD-driven) correction higher kicked in. A tactical dollar pause is at hand but the euro remains strategically under pressure. It takes a return above EUR/USD 1.035 to call off the immediate downside alert.

A combination of euro weakness, PM Johnson’s exit clearing some political fog, a correction in the oil price and the BoE reiterating, potentially stepping up its anti-inflation commitment, triggered a sterling short squeeze early July. EUR/GBP fell below the established uptrend before finding support around 0.84. A balance of weakness could keep the pair in a sideways 0.84/0.86 trading range. Euro weakness is a risk.

Calendar & Table

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This document has been prepared by the KBC Economics Markets desk and has not been produced by the Research department. The desk consists of Mathias Van der Jeugt, Peter Wuyts and Mathias Janssens, analists at KBC Bank N.V., which is regulated by the Financial Services and Markets Authority (FSMA). Read the full disclaimer.

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