Friday, 29 July 2022
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• Core bonds went through the roof yesterday. The US yield curve bull steepened with changes varying between -15.1 bps (5y) to -4.3 bps (30y). The 10y yield’s technical picture risks deteriorating dramatically if the drop below the lower bound of the sideways 2.70/3.50% trading range gets confirmed in coming days. German Bunds outperformed, losing a stunning 18.5-19.6 bps in the 2y/5y segment and 8.9y further out. That happened even as inflation in the country surprised to the upside (8.5% vs a decline to  8.1% expected). But markets were/are in a different state of mind since the Fed meeting. The focus was on a potential slowdown of the Fed tightening cycle, and this also affected expectations for the ECB even as it only just started normalizing. A bigger-than-expected drop in EC economic confidence to the lowest since early 2021 and especially in US GDP (-0.9%) only strengthened that market thinking. Needless to say rate moves yesterday were exclusively driven by the real yield component. This brought comfort to stock markets. Equities in Europe and the US added up to 1.2% despite facing a (or for the US: being in a technical) recession. US GDP numbers restored the balance in EUR/USD. The pair rebounded from intraday lows around 1.011 to close around 1.02. Revealing how this was dollar weakness and not euro strength was EUR/CHF, which closed at a new record low. The yen outperformed. USD/JPY dropped below 135 for the first time since end June. EUR/JPY loses no less than 2.5 big figures (136.9). Sterling did well, once again, both against USD and the euro. EUR/GBP extended a trip south of 0.84.

• Currency markets trade a pattern similar to yesterday in Asian dealings this morning. The dollar, euro are weak, CHF and especially JPY gain the most. Equities rise except in Japan (yen strength) and China (Politburo gives a downbeat eco assessment). Futures point to a green open in Europe and the US thanks to solid big tech earnings. Core bonds extend a rally. Today’s economic calendar is focused on Europe with inflation for July and Q2 GDP numbers due. Risks are tilted to the upside for the former, we have a neutral bias on the latter. Also keep an eye at the US employment cost index. Powell referred to it as being an important indicator on Wednesday. Any downward surprise in the current environment could be considered as an enough reason for central banks to be less aggressive. That said, yields have declined materially already and are on the verge being out of touch with the actual central bank intentions, regardless of the growth slowdown, so we look out for/hope to see a bottom forming going into the weekend. We remain structurally cautious on EUR/USD. The dollar is rapidly losing interest rate support but in a context of recession fears, its safe haven status may soon resurface.

News Headlines

• Economic data published in Japan this morning painted a mixed picture. Industrial output rebounded sharply in June by a much stronger than expected 8.9% M/M. Easing Covid restrictions in Shanghai reduced supply disruptions for several industries, including the automobile industry, electronics and communication equipment. June retail sales unexpectedly dropped 1.4% M/M causing Y/Y growth to slow to 1.5% from 3.7% Y/Y in May. Higher prices probably slowed consumer spending. In this respect, the July Tokyo CPI rose slightly faster than expected. Headline CPI came in at 2.5% Y/Y from 2.3% Y/Y in June. The core measure (ex fresh food and energy) accelerated from 1.0%Y/Y to 1.2%. The unemployment rate stabilized at 2.6%. The yen strengthens further this morning to USD/JPY 133.4, but this is mainly due to recessionary fears in the US and a sharp decline in US yields rather than the Japanese data.

• According to sources spoken by Reuters, OPEC and its allies when meeting next week will consider keeping oil output unchanged in September. Some sources suggested that a modest increase also could be discussed. By August, OPEC+ will have reversed the production cuts that were installed since 2020 due to the pandemic. The debate on a stable OPEC production comes as President Biden at his latest visit to Saudi Arabia called on country to step up production to address high oil prices and their impact on global/US inflation. After a brief drop below $100 p/b earlier this month, Brent oil currently again trades near $ 108 p/b even as markets are pondering growing risks to global growth.



The ECB ended net asset purchases and lifted rates with a 50 bps inaugural hike. More tightening is underway but the ECB refrained from guiding markets on the size of future rate hikes. Economic indicators however show growth is stalling or even contracting. Markets doubt whether tightening may last in 2023. Germany’s 10-yr yield extended a correction lower. After breaking important support at 1.12% and 1.03%, 0.73% is the next reference.

The Fed hiked to neutral by a back-to-back 75 bps in July. The size of future moves depend on the incoming data. QT will hit max speed by September. But markets begin questioning the Fed’s hawkish intentions following a string of weak data. Yields at all tenors are under pressure as a result. The 10y yield dropped below the lower bound (2.70% area) of the sideways trading range. A confirmation in coming days deteriorates the picture dramatically.

The euro zone’s (energy) crisis is being accompanied by an Italian political crisis. Growing recession fears hammered EUR/USD below the 2017 low of 1.0341. Parity was tested before a technical (USD-driven) correction higher kicked in. A tactical dollar pause is at hand but the euro remains strategically under pressure. It takes a return above EUR/USD 1.035 to call off the immediate downside alert.

A combination of euro weakness, PM Johnson’s exit clearing some political fog, a correction in the oil price and the BoE reiterating, potentially stepping up its anti-inflation commitment, triggered a sterling short squeeze early July. EUR/GBP fell below the established uptrend before finding support around 0.84. A balance of weakness could keep the pair in a sideways 0.84/0.86 trading range. Euro weakness is a risk.

Calendar & Table

Date Source: Bloomberg


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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).
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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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