Wednesday, 6 April 2022
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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 winddown 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.


European yields recovered from the early stages of the Russian-Ukrainian war as the expected growth slowdown didn’t deter the ECB from formally stepping up the normalization plans. QE is to end in Q3 with a rate hike in the next quarter. First meaningful correction in over a month as the threat of new sanctions makes the ECB’s balancing act even tougher.

The Fed started its tightening cycle and published an aggressive blueprint for the remainder of the year. A 50 bps rate hike May is likely. The US yield curve extended its bear flattening trend. Plans to shrink the balance sheet will be published in May. Medium term, the sell-off on core bond markets isn’t over.

The ECB sticking to – accelerating even – the normalization schedule is a (latent) positive for the common currency. After first protecting EUR/USD’s downside, it next triggered a test of first resistance at 1.1121. A sustained break higher didn’t occur with the pair now at risk of falling out a closing triangle pattern as stakes in the Russian war are raised. A break lower puts EUR/USD 1.0806 back on the radar.

EUR/GBP took out the first resistances between 0.82 and 0.83. The March ECB and BoE meetings restored some kind of monetary policy balance. The BoE even turned more dovish, but markets question this turn. EUR/GBP is showing signs of bottoming out.

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).
These market recommendations are the result of qualitative analysis, incorporating room for past experiences and personal assessments. The views are based on current market circumstances and can change any moment. The most prominent input comes from publicly available data, financial news, economic and monetary policies and commonly used technical analysis.
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