Wednesday, 20 July 2022
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•          After recessionary fears dominating market sentiment of late, markets yesterday were gradually captured by a remarkable, some kind of ‘reflationary dynamics’. This was especially the case for European markets. Investors pondered whether enough bad on news on European gas supplies was discounted. The change in sentiment was supported by a Reuters report citing sources familiar with the topic that Russian gas supply from the Nord Stream 1 pipeline will resume on Thursday (admittedly probably still at a reduced capacity). It reinforced the feeling that a worst case scenario could be avoided, supporting regional and global risk sentiment. At the same time, sources close to the ECB also were referred to reporting that the internal debate on a 50 bps rate hike at tomorrow’s ECB meeting is still open. The combination of a risk-rebound and a repricing of expectations on ECB policy triggered a bear flattening on European interest rate markets. German yields rose between 11.5 bps (2-y) and 2.9 bps (30-y), confirming recent bottoming pattern. The US yield curve showed a similar but less outspoken move (2-y + 6.3 bps, 30-y + 2 bps). A similar bottoming out pattern is also developing in equity markets. US indices jumped between 2.43% (Dow) and 3.11% (Nasdaq). The EuroStoxx50 reversed an opening loss to close 2.15% higher. Yesterday’s markets dynamics also triggered a further EUR/USD short-squeeze with both euro strength (ECB driven) and further dollar correction (risk-on) in play. The DXY TW dollar dropped from the 107.50 area to close at 106.7. Sterling gained against the dollar (cable close near 1.20), but eased further against the euro (EUR/GBP close 0.8525). BoE Bailey at its Mansion house speech indicated that a 50 bps for the August meeting is on the table, but is ‘not locked in’. The BoE might start QT in September with a possible pace of asset sales of £50-100 bln in the first year.

•          Asian markets this morning are joining the risk-rebound from Europe and WS yesterday with gains equity indices rising up to 2.5% (Nikkei). China underperforms. The dollar maintains yesterday’s losses (DXY 106.55). Later today, the eco calendar in Europe and the US is thin. EC consumer confidence (expected to decline further) and US existing home sales are interesting, but only of intraday significance for trading. Italian PM Draghi will address the Senate with a confidence vote expected afterwards. Several members of the coalition recently indicated they intended to withdraw support. Both Italian spreads and the euro recently reacted in a very orderly fashion the Italian political crisis. Focus on European markets will remain on tomorrow’s ECB meeting. Markets currently discounted about 50% of a 50 bps hike. So, if the ECB joins the frontloading trend, the bottoming out pattern/rebound on European interest rates markets has further to go. This also should provide some further relief for the euro. However, it will probably take more positive news (e.g. on Russian gas supply) for EUR/USD to sustainably regain the 1.0350 resistance. This morning, UK June CPI was reported at 0.8% M/M and 9.4% Y/Y (from 9.1%). Core inflation eased from 5.9% to 5.8%. Data were close to expectations. Sterling trades little changed in a first reaction (EUR/GBP 0.852).

News Headlines

•          RBA governor Lowe highlighted the importance of having “a credible path back to 2-3% inflation in which the economy grows and unemployment stays low”. For this to happen, a steadily increasing cash rate is necessary. Lowe said its probable that it will have to be raised beyond 2.5%, the estimated neutral rate, with the pace of hikes set by the inflation outlook. The RBA raised rates three times since May: first by 25 bps, then by 50 bps back-to-back hikes. Some are betting for even bolder moves as soon as next month (Aug 2) on expectations that next week’s Q2 inflation print will have accelerated even further from the 5.1% y/y seen in Q1. Fast rising prices, well beyond the RBA’s target, has triggered criticism, not least politically. It long held a dovish stance, pledging no hikes before 2024, when many of its peers were already doing so. During his speech yesterday, Lowe acknowledged forecasting has been “embarrassing” but defended policy choices saying it was right to err on the side of too much rather than too little. Australian Treasurer Chalmers nevertheless decided to create a panel to review the central bank’s performance (including choice of policy tools), governance and culture. The report is due no later than March 2023.


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%/1.12% was tested but survived.

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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