Friday, 15 July 2022
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•          European bond yields started off with a massive surge yesterday. We view it as a belated catch-up move with their US counterparts following the CPI release on Wednesday. Both German yields and European swap yields rose almost 20 bps intraday at the short tenors. But doubts soon emerged once again with an unfolding Italian political crisis (cf. infra) obviously not helping sentiment. Germany’s curve bear flattened with changes ranging from +0.3 bps (30y) to 6.5 bps (2). Europe’s 10y swap yield tried to settle north of 2% again but missed it by an inch (1.998%). Peripheral spreads widened up to 7 bps in Italy and 8 bps in Spain. US Treasuries outperformed Bunds. Two FOMC hawks poured cold water over a 100 bps hike in July. Waller said markets were getting a bit ahead of themselves. 75 bps is still his base case without ruling out a 1ppt hike depending on the upcoming retail sales and housing data. Bullard also favours a back-to-back 75 bps move that would bring the Fed in neutral territory. He argues for a 3.5% policy rate by end 2022 and is “not really looking to do more in 2023” unless the data forces otherwise. The wings of the US yield curve outperformed (-1.4 to -2.3 bps) the belly (up to 3.8 bps higher). In FX markets, dollar dominance continued though momentum faded slightly in early US dealings. The trade-weighted index nevertheless hit a new cycle high of 108.54. USD/JPY rallied to 138.96. EUR/USD dipped below 1 as far as 0.9955 before rebounding and closing above parity still. The (dollar) turnaround coincided with a bottoming in oil prices. Brent lost support from the 200dMA to go as low as $94.5/b but then staged a comeback to close the day at $99.10. Stocks in Europe lost more than 1.6%. WS ended 0.5% lower (DJI) to flat (Nasdaq).

•          Asian-Pacific stocks trade mixed. Chinese Q2 growth disappointed (see below) but leaves no material traces on markets. The dollar consolidates near recent highs and core bonds gain a few ticks. Today’s economic calendar got even more interesting after Waller’s comments yesterday. We therefore keep a close eye at US retail sales but also at the Michigan consumer confidence. In June, the inflation expectations questionnaire made the Fed step up its game. Bond markets would definitely notice a further increase, especially if the retail sales don’t disappoint. Barring such a scenario, we think both bond yields and the dollar could take a breather going into the weekend. The US 10y yield hovers around the 3% mark. Some USD consolidation at the current strong levels is possible with a lingering risk for EUR/USD 1 to snap. More Fed governors speak ahead of the black-out period.

News Headlines

•          The political crisis in Italy continues. Italian President Mattarella rejected Prime minister Draghi’s resignation and asked the PM to address Parliament next week. PM Draghi decided to resign as he concluded that the government of national unity didn’t exist anymore after the 5-Star Movement didn’t participate in a vote on a package to support the population from rising prices which it considered as not sufficient. The coalition still has a majority in Parliament but Draghi indicated that he didn’t want to continue the government if it wasn’t supported by 5SM, which was the biggest group in Parliament. The coalition also has divergent views on how to react to the Russian invasion in Ukraine. President Mattarella not accepting Draghi’s resignation buys time, but the risk of early elections persists. The crisis comes at difficult time, both for Italy and Europe. The Italian 10-y bond spread versus Germany yesterday widened an additional 7 bps and the crisis in Italy probably was a factor for EUR/USD to (temporarily) drop below parity.

•          Growth in China in the second quarter contracted a bigger-than-expected 2.6% Q/Q as covid restrictions in April and May reduced demand and weighed on production. Activity in China was only 0.4% above the level of the same quarter last year. YTD growth printed a 2.5% and suggests that it will be difficult to reach the government target of 5.5% this year. At the same time, production (3.9% Y/Y) and retail sales (3.1%) data for the month of June indicated a better economic performance in the last month of the quarter. The picture for the Chinese property market continues to look bleak with investment in the sector declining 5.4% YTD, more than anticipated.


The ECB turned the corner in its inflation narrative. The central bank ended net asset purchases, facilitating rate hikes from this month. German 10-yr yield pushed through to the highest level since early 2014. The move ran into resistance at 1.9% (50% retracement on long term decline) before correcting lower on increasing growth worries. First important support at 1.18%/1.15% remains under pressure.

The Fed started an aggressive tightening cycle. Another (June) inflation surprise raised the odds for a 100 bps hike in July instead of the flagged 75 bps one. QT will hit max speed by September. But markets discounted a good deal already and focus is at least as much on growth. The 2.72% area was tested but didn’t break. Sideways consolidation over the summer is in the cards.

The euro zone’s (energy) crisis is being accompanied by an unfolding Italian political crisis. Markets ponder the ECB’s ability to deliver rate hikes in such circumstances, even with inflation being sky high. Growing recession fears hammered EUR/USD below the 2017 low of 1.0341. Parity is being tested. A sustained break lower paves the way towards intermediate support around 0.96 before a return to the all-time low of 0.823.

The BoE in June signaled it might step up tightening. Initially this didn’t help sterling. However, a combination of euro weakness, PM Johnson leaving, the sharp correction in the oil price and the BoE reiterating its anti-inflation commitment, finally triggered a sterling short squeeze, pushing EUR/GBP below the established uptrend.

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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