KBC Sunset Market Commentary 25/10/2022 via Trader Talent

• The correction higher on core bond markets continues today. US yield drop 4.7 bps (2-yr) to 7.6 bps (7-yr) with the belly of the curve outperforming the wings. The German yield curve bull flattened with yields dropping over 10 bps at the very long end of the curve. First signs of the correction appeared last Friday during US dealings, linked to a WSJ article suggesting Fed rate hikes to slow down to 50 bps from December on. The monthly batch of global PMI’s added to bond moves amid a significant weakening in growth momentum. With 75 bps rate hikes discounted for both the ECB (Thursday), Fed (next Wednesday) and BoE (next Thursday), it turned out tempting to scale down bets awaiting the effective outcomes and especially forward guidance for final policy meetings of this year.
 
• We’ll take a closer look at the ECB meeting. Money markets agree on Thursday’s 75 bps hike but are split on the December outcome between 50 bps and 75 bps. We side with the latter. September EMU inflation beat forecasts again at 9.9% Y/Y suggesting that the September ECB CPI forecasts are once again outdated. As long as labour markets stand strong, we see no reason for the ECB to decelerate its tightening efforts already despite weak growth momentum. Mild autumn weather also postpones any potential impact from the energy crisis with most European stockpiles filled. Furthermore key policy rates aren’t in neutral territory yet, let alone restrictive. Several ECB members stressed the need to go that far: actively constraining demand for the higher goal of delivering price stability in the longer term. Money markets put the ECB policy rate peak level at 2.75%-3% by mid next year which we think is way too conservative. Apart from the rate decision, the ECB will communicate on the structure of outstanding TLTRO’s. The central bank wants to by-pass that cheap loans it has granted during previous crisis years to kickstart the economy get rerouted to its own deposit facility which all of a sudden looks very attractive following back-to-back large rate hikes. Sources suggest that three possible options remain. The first and most simple one is unilaterally changing the terms of the TLTRO’s so that cash from the operations parked at the ECB would not be remunerated at the deposit rate. A second possibility consists out of treating TLTRO cash in the same way as minimum reserves, which are currently remunerated at 0.5%, below the 0.75% deposit rate. The final solution is some sort of reverse tiering that would allow for a more favourable remuneration up to a certain threshold, after which a lower rate would apply. Finally, the ECB could indicate that it is working on a plan to wind down its asset portfolio APP (+-€3.2tn). ECB President Lagarde already said that this would start once rates hit neutral (ie by the end of the year). An early 2023 start of APP tapering (QT) is the most plausible scenario.
 
News Headlines

• The quarterly business sentiment indicator of the confederation of British industry fell sharply in October, from -21 to -48, the lowest level since April 2020 Total orders declined from -2 to -4, but that was less than feared. Volume of expected output moderately improved from -17 to 7. Interestingly, the subindex measuring average selling prices for the next three months eased from 59 to 46, bringing it to the lowest level since September last year. However other price measures in the Quarterly trends survey showed a more mixed picture with the measure of domestic price growth easing from 48 to 46 while the index of average unit costs stayed near the cycle peak level at 82 (from 77).
 
• The National Bank of Hungary left its base rate unchanged at 13% and reiterates that maintaining the current level of the base rate for a prolonged period is consistent with the achievement of the price stability objective over the monetary policy horizon. The MNB states that the targeted and temporary measures taken in mid-October support the management of market risks and promote a balance between supply and demand in the FX market. By raising the upper bound of the interest rate corridor by 950 bps, the tighter interest rate conditions on overnight quick deposit tenders (currently 18%) and FX swaps are raising short-term rates and properly influencing interest-sensitive capital flows. The impact of non-interest-sensitive market developments is offset by the commitment to directly meet major FX liquidity needs arising from covering net energy imports in the coming months. The MNB concludes that tight monetary conditions will be maintained from a prolonged period of time.