KBC Sunset Market Commentary 27/10/2022 via Trader Talent

• The ECB raised its key policy rates by the expected 75 bps for a second time straight. The deposit rate now stands at 1.5%. The statement contained some dovish twists compared to the previous one. It mentioned that further rate hikes are necessary though it left out stating that this will happen over “the next several meetings”. It also added that the GC in the meantime made “substantial progress in withdrawing monetary policy accommodation”. Future policy decisions will be based on the evolving outlook for inflation and the economy (italic part was added). The ECB also moved to address the TLTRO issue where cheap loans find their way back to the central bank’s (bigger-yielding) deposit facility. The terms (ie applicable interest rate which currently can be as low at -1%) will be adjusted from November 23 in the manner outlined in a separate statement to be disclosed after finishing this report. During the press conference, president Lagarde struck a gloomy note on the economy. Growth slowed in Q3 and is expected to decrease further in Q4 and early next year. A massive terms of trade shock is weighing on incomes and inflation is dampening spending and production. Confidence levels have fallen recently. Risks to growth are “clearly tilted to the downside”, especially in the short term. The labour market is holding strong for now in a rare bright note. Inflation however is much too high and the balance of risks is “primarily” tilted to the upside. A further increase in retail energy prices and/or bigger than expected wage pressures could make those materialize. This means the ECB “has more ground to cover” but Lagarde refrained from guidance on its size. She simply referred to three key elements the ECB is considering when setting rates: the inflation outlook, what tightening has been delivered already and the time lag of monetary policy. On the reduction of the balance sheet, Lagarde said they deliberately didn’t discuss it. That’s a matter for December, when the ECB will outline the key principles of quantitative tightening.

• Markets took today’s meeting as a signal that the ECB will shift to a slower pace of tightening from December on. We understand why with the current mindset having shifted since last Friday. But we think it is premature in a context of inflation time and time again having proven to be much stickier than most, including the ECB, foresaw. Let’s see tomorrow’s German inflation numbers for a first check. The market reaction meanwhile is textbook: swap yields tumble 12.9-13.8 bps at the front end with the 2y yield having the eyes set at the 2.5% support zone (neckline double top formation). The 10y yield (-9.8 bps) is headed for key support at 2.72%. Money markets pare tightening bets to an overly cautious 2.5% by mid-next year. EUR/USD returns some of its dollar-driven gains over the previous days. The pair is testing parity again. European stocks recover from an intraday 1.1% drop (EuroStoxx50).

News Headlines

• In its IV-2022 inflation report, the Central Bank of the Turkish Republic raised the midpoint for its end 2022 inflation forecast from 60.4% to 65.2%. The end-2023 midpoint forecast was upwardly revised from 19.2% to 22.3%. The disinflation path assumes commodity prices will gradually converge to historical averages due to slowing global demand amid tighter financial conditions. At the same time, the CBRT mentions the stabilizing effects of the macroprudential measures taken under the liraization strategy, the support of potential supply through the financing cost channel, the stable course of the foreign exchange market and the improvement in inflation expectations as factors that will bring pricing to a normal level. As a reminder, headline inflation in September printed at 83.45% Y/Y. Core inflation was 68.09% Y/Y. At a press conference, Governor Kavcioglu admitted the CBRT hasn’t been very successful in easing prices pressures.

• US GDP growth in the second quarter rebounded to an annualized pace of 2.6% Q/Q from a 0.6% contraction in the second quarter. The figure was marginally stronger than expected. The details of the report were mixed. An important contribution to growth came from an improvement in net exports as export growth outpaced import (2.77% net contribution). Personal consumption also contributed positively, but the pace of growth slowed from 2.0% Q/Qa to 1.4%. Gross private investment weighed on growth as a rise in non-residential fixed investment (equipment, intellectual property) was more than counterbalanced by a decline in residential investment. Government consumption was a modestly positive contributor (2.4% quarterly growth). The core PCE deflator eased slightly from 4.7% to 4.5, in line with expectations.