Wednesday, 21 September 2022
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•          A series of ‘smaller events’ (bigger than expected Riksbank rate hike, high German PPI) triggered another sell-off in core bonds yesterday. European swap yields added 8.6 bps (2-y) to 11.1/11.5 bps (10 & 5-y). The 2-y rate touched a new multi-year top. The 10-y EMU swap tested the cycle peak at 2.72%. US yields rose between 3.1 bps (2-y) and 7.3 bps (10-y). Interesting observation: the curve slightly re-steepened despite market expectations for a hawkish Fed today. Later in the session, LT US bonds finally got some relief from a strong 20-yr auction. Also remarkable, it was not only the real yield, but also/even more inflation expectations that drove the rise in LT yields (10-y). It didn’t hurt the dollar. At 110.21, the DXY index again closed within reach of the cycle top. EUR/USD dropped below parity to close at 0.997. Sterling traded volatile intraday as the rise in UK yields even outpaced the US and the EMU. However, in the end, it didn’t yield sterling that much. EUR/GBP closed only marginally lower at 0.8761. Cable (close 1.138) narrowly avoided a new multi-year low. Equities in Europe and the US again lost about 1%.
•          With hardly any market moving data scheduled, one would expect today’s trading session to be a long-drawn countdown to this evening’s Fed policy announcement. However, markets of late didn’t need any news to continue their sharp hawkish repositioning. Question now is how hawkish this evening’s Fed message will be. A 75 basis points rate hike is fully discounted with markets seeing about a 1 in 4 chance for a 1.0% step (target range currently at 2.25%/2.5%).The new dot plot summarizing expectations from the individual governors is at least as important as the actual size of the Fed rate move. Quid on the governors’ expected inflation path? Quid on the new anticipated rate path? Quid on the long term neutral policy rate? At the June dots, Fed governors on average saw the Fed fund rate at 3.4% end this year and peaking near 3.8% next year. Markets currently already discount a rate peak near 4.5% in Q1 next year. Will Fed governors even exceed market pricing? With the neutral rate in June at 2.5%, policy from now will be in outright tightening modus. However, if this reference changes, the Fed has room to do more, especially if aggregate demand slows less than expected. Markets also still didn’t fully give up on the idea that after current aggressive tightening, there might already be room for gradual easing later next year. How strongly will the dots and Chair Powell fight this idea? The Fed will be hawkish. The market is prepared for such a message. It would be too easy to conclude markets might have reached a short-term equilibrium. For now we don’t expected a sustained buy-on the rumour, sell-the-fact profit taking move on the recent strong rise in yields yet. The dollar will likely stay strong as it remains difficult for other central banks to match the Fed’s tightening efforts. A test of the DXY 110.78 cycle top remains a decent possibility. Looking forward to tomorrow, we also keep a close eye at USD/JPY. The BOJ this morning announced unscheduled additional bond buying to prevent the 10-y yield from rising further beyond the 0.25% cap. Is this a precursor of the BOJ holding to its easy approach? If so, the chance/need for real interventions will grow, even as it will be difficult for the BOJ to fight USD strength even more than yen weakness.

News Headlines

•          ECB President Lagarde delivered a speech on monetary policy in the euro area for the Frankfurter Gesellschaft für Handel, Industrie und Wissenschaft. She elaborates on the shocks which resulted in unprecedented inflation levels: the pandemic and the Russian invasion. Looking ahead, two major shifts risk resulting in structurally higher inflation: the green transition and an end to globalization. When it comes to future monetary policy, she said that if there were evidence that high inflation risked de-anchoring inflation expectations, then ECB would hike policy rates into restrictive territory. For those who doubted. Monetary policy will be set with one goal in mind: to deliver on the central bank’s price stability mandate.


The ECB ended net asset purchases and lifted rates with a 50 bps inaugural hike and a 75 bps follow-up move. More tightening is underway but the ECB refrained from guiding markets on the size of future hikes. Germany’s 10-yr yield broke out of the corrective downward trend channel since mid-June, suggesting more upside. The YTD high at 1.93% is tested again .

The Fed hiked to neutral by a back-to-back 75 bps in July. The size of future moves depends on the incoming data. QT hits max speed. The 10y briefly dropped below the lower bound (2.70% area) of the sideways range, but a sustained break lower was averted. The 3.50% barrier is under test as the focus is back on Fed frontloading to tackle inflation.

EUR/USD is in a strong downward trend channel since February. Last week’s hawkish ECB meeting, attempts to tackle the energy crisis and a risk rebound gathered some euro-momentum. The upper bound of the downward trend channel kicks in as first resistance around 1.0150.

The Bank of England hiked by 50 bps in august. More hikes are coming but are priced in already. Combined with the BoE’s grim economic assessment it triggered a profit-taking move. EUR/GBP broke out of the corrective downward trend channel since mid-June and extended gains beyond the key 0.8721 YTD level. 0.8866 is next reference on the charts.

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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