• Core bonds extended their renewed sell-off momentum yesterday. UK Gilts underperformed German Bunds & US Treasuries, with a different curve dynamic. UK yields added 8.9 bps (2-yr) to 13.4 bps (10-yr) on a daily basis. The (very) long end of the UK curve underperformed both because of Fitch downgrading the outlook on the country’s AA- rating to negative and as the Bank of England’s emergency support programme draws to an end next week. Both items are linked to the government’s lavish, debt-funded, fiscal stimulus plans and caused a repricing of UK credit risk premia. For Germany and the US, the front end of the curve underperformed with the former bear flattening and the latter turning more inverse. German yields increased by 1.1 bp (30-yr) to 10.7 bps (2-yr). Although ECB Minutes revealed that some governors argued in favour of only a 50 bps September rate hike, they were hawkish to the bone. Even ECB chief economist Lane, architect of the past years’ accommodative monetary policy, seemed to have turned the page. Rate hikes of (at least?!) 75 bps at October and December policy meetings are a done deal to us. US yields closed the trading day 3.1 bps (30-yr) to 10.9 bps (2-yr) higher following a plethora of hawkish Fed comments, defending the updated September dot plot (4.5-4.75% policy rate peak early next year). The dynamic in US eco data releases improved as well throughout the week, pushing the US slowdown/recession scenario’s temporary to the background. We started with a disappointing US manufacturing ISM followed by the second largest drop ever in US job openings (coming from record levels), but a decent ADP employment report and strong services ISM took over. The proof of the eating will be in today’s payrolls report with consensus expecting a 255k net job gain. Anything bar a huge disappointment won’t derail strong underlying market trends. The intensification of the bond sell-off spilled to stock markets yesterday with main European benchmarks losing up to 0.5% and US indices up to and over 1%. The dollar ranked first amongst majors with EUR/USD losing the 0.98 big figure this morning, USD/JPY only staying below 145 by the grace of Japanese FX interventions and the trade-weighted dollar marching from an open around 111 to beyond 112. A touch of sterling weakness added to cable’s dismal performance. The pair rebounded post-BoE long gilt interventions towards the 1.15 area (previous support turned into resistance), but failed to recapture that level. The current playing field is 1.1170.
• Canadian 2y (swap) yields surged to the highest level since 2007 yesterday. A 12/13 bps jump followed hawkish comments by Macklem. The BoC governor downplayed a two-month easing in headline inflation (to 7% in August) and said underlying price pressures remain elevated. Core measures averaged 5.2% in August. Inflation (expectations) risks becoming entrenched and require further monetary tightening. “Simply put, there is more to be done.” In a sign the BoC will continue to hit the brakes hard, Macklem said the central bank isn’t ready for “finely balanced” rate hikes. Canadian money markets before the speech penciled in a terminal rate of 4% compared to 3.25% today. That rose to 4.5% afterwards. The loonie lost ground nonetheless vs a much stronger dollar. USD/CAD rose from 1.362 to 1.375. The Canadian dollar for most of 2022 held relatively steady vs the USD but shed considerable territory since mid-September. Macklem said this depreciation has offset some of the global supply improvements.
• European carmakers scrapped expectations dating from the beginning of this year for a bit of growth this year. Passenger car sales will probably drop 1% to 9.6 million in 2022. The ACEA, representing the industry, cited a series of setbacks, ranging from Brexit over semiconductor shortages to the war in Ukraine and the energy crisis. Concerns have shifted from constraints on production, affecting supply, to runaway inflation and recession fears, weighing on demand. The ACEA is calling for policy makers to step up support and create the right framework to ensure a return to growth. This includes improving resilience in Europe’s supply chains and ensuring access to raw materials needed for e-mobility.
The ECB ended net asset purchases and lifted rates by a combined 125 bps at the July and September meetings. More tightening is underway but the ECB refrained from guiding markets on the size of future hikes. Germany’s 10-yr yield rose to its highest level since 2011 (2.35%) with real rates driving the push higher. First support in case of corrections stands at 1.71% (38% retracement on August/September move).
The Fed policy rate entered restrictive territory, but the central bank’s job isn’t done yet. The policy rate is expected to peak above 4.5% early next year and remain above a neutral 2.5% over the policy horizon. QT hits max speed. The 10y reached its highest level since 2008 (4.01%). Support stands at 3.5%/3.44%
EUR/USD is in a strong downward trend channel since February. The dollar remains the main beneficiary of rising US (real) yields in a persistent risk-off context. Geopolitical and recessionary risks are bigger for Europe, holding down the single currency as well even as the ECB finally embraced on a tightening cycle. Resistance stands at EUR/USD 0.9950/1.0050.
The UK government had to backtrack on part of its lavish fiscal spending plans which sent sterling initially tumbling towards the EUR/GBP 0.90+ area. Yawning twin deficits and rising risk premia will continue to weigh on the UK currency even as markets think that the BoE will have to counter fiscal support with additional monetary tightening.
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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