• European markets were put immediately on edge even before the official open. Financial media reported that the ECB would hold an emergency meeting to discuss “current market conditions”. Investors concluded this meant addressing the steep rise in yields/spreads for heavily indebted countries, including Italy. The massive drop in the 10y Italian yield of more than 40 bps ahead of the meeting’s outcome suggested they were expecting something way more than promising “PEPP reinvestment flexibility” announced at the regular meeting last week. In a sign that widening spreads became an issue for the common currency once again, the euro staged a small rebound towards EUR/USD 1.05. Alas, it became a tale of over-promising and under-delivering. The ECB simply announced that “it will apply flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to preserving the functioning of the monetary policy transmission mechanism.” Regarding any new anti-fragmentation instrument, the ECB gave its staff instructions to hurry up its completion a bit. European bond markets, both core and peripheral, pared some of the early morning gains shortly after the statement was released in a sign of disappointment. However, the sharp recovery resumed soon thereafter with the move coinciding with the publication of May US retail sales. The headline figure printed negative for the first time in five months (-0.3% m/m), core gauges rose less than expected and the April readings were revised downwardly. German Bund yields slip 17.2-20 bps in the 2-5y bucket. Tenors further out shed 15 bps (10y) with the very long end underperforming (30y: -5.8 bps). Peripheral spreads vs. Germany’s 10y yield tank between 10 (Spain and Portugal) over 22 bps (Italy) to 27 bps (Greece). US yields nosedive between 6.2 bps (30y) to 11.6 bps (5y) lower ahead of the Fed policy meeting. EUR/USD forfeited all gains to trade slightly lower in the low 1.04 area even as risk sentiment is not at all bad (stocks trade 1-2%+ higher). EMU/US interest rate differentials may be at play here. Sterling shrugs of news that the EU is resuming legal action against the UK over the implementation of the NI protocol while simultaneously launching a second case on matters regarding custom checks. It follows Johnson’s bill to unilaterally amend the protocol earlier this week. EUR/GBP eases from above 0.87 to 0.863 currently. Cable tries to safeguard the 1.20 big figure.
• With the ECB having laid an egg, we can now turn to what was supposed to be the one and only focal point today: tonight’s Fed policy meeting. Newspaper reports on Tuesday paved the way for a 75 bps hike instead of the 50 bps hinted at by the Fed at the previous meeting. Such a big move last happened in 1994. We believe chair Powell will rubberstamp another 75 bps hike in July unless the inflation outlook improves materially. In essence this would confirm current market expectations and should thus not come as a big surprise. The dot plot will probably already be outdated if only because it won’t reflect tonight’(and July’s) bigger-than-previously announced rate hike. Governor estimations of the neutral rate (2.4% previously) is worth looking into though. Raising it de facto means the Fed expects the high inflationary environment to stick around for longer. Powell’s tone may prove all-important for US bond markets and the dollar. Keep a close eye at EUR/USD. 1.035 is extremely close. A break lower brings parity back on the radar …
• Bulgaria’s government of Prime minister Kiril Petkov will face a no confidence vote in Parliament next week. The vote was filed by the Gerb party of Center-right former Prime Minister Borissov and comes after the junior party left the coalition government last week. As reason of the no confidence vote, the opposition mentions the government’s failure in its economic and fiscal policy, including the government’s ability to address surging inflation. Today, Bulgaria reported May inflation figures at 1.2% M/M and 15.6 % Y/Y (from 14.4 in April), the highest level since 1998. Political uncertainty can complicate the country’s plan to join the euro in 2024.