Thursday, 3 February 2022
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Markets

•          You could almost hear jaw drops in Frankfurt yesterday. European inflation unexpectedly accelerated to 5.1% y/y in January, defying expectations for a base-effect driven decline. Core inflation fell by less than hoped for, to 2.3%. Euro area money markets stepped up rate hike bets ahead of the ECB meeting (today). They now discount a total of +-25 bps rate increases by the end of this year. Short-term bond rates added 1.2-2.2 bps (2y-5y German Bund) and 2.7-3.4 bps (2y-5y swap). The long end outperformed, remaining unchanged or declining 1 or 2 bps. The euro, as ever, fails to really profit from the ongoing yield increase at the front end of the curve. EUR/USD did rise to 1.1305, up from 1.1272, but mainly thanks to the dollar still correcting lower (DXY fell from 96.38 to 95.8). EUR/USD failed to settle within the upward sloping trend channel. US data disappointed (ADP -301k vs +180k expected) but left no permanent traces on markets. US yields struggled, much like they have been doing over the past few days. The curve shed up to 1.4 bps across the curve. The 2y yield extended a gentle topping out pattern near 1.20% while the 10y variant oscillates around the 1.80% pivot. Wall Street shrugged at the data and finished in the green with gains up to 1% (S&P). Futures in early trading (>2% lower in the Nasdaq) paint a completely different picture for today though after tech bellwethers Meta Platforms (Facebook parent) and Spotify delivered bleak guidance. Asian cash trading is mixed with Japan declining 1% but South Korea opens to 2% higher after a few days off. Core bonds eke out small gains. The dollar snaps a three-day decline.

•          It’s D-day for several central banks today, from the Czech National Bank (75 bps hike expected) over the ECB to the Bank of England. The latter is poised to deliver its first back-to-back rate hike since 2004. Hiking rates to 0.5% would trigger a natural balance sheet roll off too. The 25 bps increase is completely discounted. The key question for sterling is how aggressive the Bank of England will sound and how it sees inflation evolving based on current market policy rate expectations: will it be (more) than enough for a return to the 2% target? Markets have penciled in a total of five 25 bps moves for 2022 with a peak rate of about 1.6% in 2023. This leaves some scope for disappointment. The downside in EUR/GBP – with strong support in the high 0.82 area – should be well protected. The much higher than expected European (core) inflation piles pressure on the ECB, which meets after the BoE. We expect Lagarde to stick to the script outlined in December nevertheless, i.e. shelving PEPP in March, temporarily raising APP and refrain from interest rate hikes this year for the time being. A (verbal) policy U-turn is more likely to happen when it’s backed by new forecasts in March or June at the latest. The lack of central bank commitment will probably hurt the euro more than euro area money and bond markets. EUR/USD’s dollar-driven recovery over the recent days may soon run into resistance. 1.1186 marks the first support (Nov 2021 low).

News Headlines

•          The Brazilian central bank (BCB) raised its key Selic rate as expected by 150 bps from 9.25% to 10.75%. The BCB pursued an aggressive tightening cycle since March last year, delivering a cumulative 875 bps rate hikes up until now. However, for its next steps, the MPC foresees as adequate at this moment a reduction in the hiking pace. It refers to the stage of the tightening cycle with the cumulative effects of the efforts made kicking in with a time lag and being visible over the relevant horizon. The BCB specially mentions 2023 when it forecasts inflation at 3.2%, just below the 3.25% target. The BCB sees its policy rate peak at 12% in H1 2022 (5% above inflation and 8.5% above the neutral rate) with and end of year forecasts for 2022 and 2023 respectively at 11.75% and 8%. The MPC stresses risks in both direction to its reference scenario. Downside (inflation) risks stem from decreasing international commodity prices (measured in BRL). Upside inflation (and country credit) risk(s) come from the government’s fiscal spending spree. USD/BRL followed the dollar correction lower of the past days, currently trading around 5.26, the strongest BRL-level since September last year.

Graphs

Long term EU bond yields sprinted higher end December after the ECB didn’t really commit to strong asset buying post-PEPP with a potential end by late 2022. The move was driven by higher real rates. The break above -0.20% was a first technical hurdle and was eventually followed by a return into positive territory by a higher-than-expected German/European CPI.

The US 10-yr yield took out the October top at 1.7%. The psychological 2% mark is next resistance. The Fed’s hawkish policy turn triggered a surge in real yields. A March rate hike and June start of balance sheet reduction become the most likely scenarios. Core bonds and stocks to sell-off in lockstep again?

The dollar fell prey to profit taking after December inflation data. EUR/USD was able to escape the 1.1186/1.1386 trading channel in place since end November, but the pair failed to take out next high-profile resistance at 1.1495 as surging US real yields came to the greenback’s rescue. The November low at 1.1186 was under pressure before calling off the technical test on a dollar correction.

EUR/GBP fell below the previous sell-off low at 0.8381 in the wake of the Bank of England’s first rate hike since July 2018. UK Gilts underperform German Bunds with another rate hike by the BoE in February being our base case. Next target stands at EUR/GBP 0.8282 though the UK currency has already discounted quite some short-term interest rate support.

Calendar & Table

Note: All times and dates are CET. More reports are available at KBCEconomics.be which you may sign up to.

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).
These market recommendations are the result of qualitative analysis, incorporating room for past experiences and personal assessments. The views are based on current market circumstances and can change any moment. The most prominent input comes from publicly available data, financial news, economic and monetary policies and commonly used technical analysis.
The KBC Economics – Markets desk has used reasonable efforts to obtain this information from sources which it believes to be reliable but the contents of this document have been prepared without any substantive analysis being undertaken into these sources.
It has not been assessed as to whether or not these insights would be suitable for any particular investor.
Opinions expressed are our current opinions as of the date appearing on this material only and can be opposite to previous recommendations due to changed market conditions.
The authors of this recommendation do not warrant the accuracy, completeness or value (commercial or otherwise) of any recommendation. Neither are the authors liable to those who receive these recommendations for the content of it or for any loss or damage arising (whether in tort (including negligence), breach of contract, breach of statutory duty or otherwise) from any actions or omissions of the authors in reliance on any recommendation, or for any claim whatsoever in respect of the content of, or information contained in, any recommendation. Any opinions expressed herein reflect the judgement at the time the investment recommendation was prepared and are subject to change without notice.
Given the nature of this advice (linked to currencies and interest rates) , the advice is overall not specific in nature.   As such there is no reference to any corporate finance contract and as such there is no 12 month overview based on the different advices.
This document is only valid during a very  limited period of time, due to rapidly changing market conditions.

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