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Markets

•          On Friday, the US October payrolls was the first reality check after Fed Chair Powell’s hawkish post-FOMC press conference. The report in globo was stronger than expected with job gains at 265k (vs 193k expected) and a substantial upward revision to the September gain. Wage growth (AHE) also remained solid, gaining 0.4% M/M to be 4.7% higher Y/Y. This for sure isn’t the substantial cooling in labour market conditions that Powell and co deem necessary to slow aggregate demand and finally break the inflationary dynamics. Admittedly, the data from the consumer survey were weaker with the unemployment rate rising from 3.5% to 3.7% and the participation rate easing to 62.2% (from 62.3%), but this for sure isn’t enough to change the Fed call’s for a 5%+ peak policy rate next year. Still the market reaction was a bit counter-intuitive. After a brief moment of hesitation, especially US short-term yields turned south in a remarkable steepening move. Fed’s Barkin in an interview reconfirming the case for a slower pace of rate hikes and leaving open the debate on the peak rate level maybe supported the move. At the end of the day, the US 2-yield eased 5.5 bps while the 30-y still gained 6.5 bps. The US 10-y real yield reversed most of its post-Fed gain (currently 1.67%). German bunds underperformed US Treasuries in a bear steeping moves with yields rising between 4.3 bps (2-y) and 6.4 bps (30-y). The move probably was supported by comments from ECB’s Lagarde as she said that just a removal of policy accommodation won’t be enough bring inflation back to 2.0%.
The constructive bond market reaction to what still is to be considered a solid labour market report also filtered through in other markets. US equity indices gained 1.2%/1.3%. The Eurostoxx50 even closed 2.65% higher. Declining short-term interest rates/differentials and a risk-on sentiment also pushed the dollar off a cliff. The DXY TW index dropped from an open just below 113 to close at 110.87. EUR/USD traded near 0.9750 at the open but finished about 2% higher at 0.9957. Sterling gained against the dollar (cable close 1.1379) but still lost against the euro (EUR/GBP close 0.876) after a soft BoE narrative post Thursday’s BoE decision.
 
•          This morning, Asian equity markets show gains of up to 2.8% on the WS performance on Friday and as the debate/speculation on China potentially easing its COVID strategy continues. US Treasuries show no clear trend. The dollar regains modest ground after Friday’s battering. Today, the eco calendar in Europe and the US is almost empty. Later this week, the US mid-term elections and the US October CPI release (Thursday) will take center stage. The US Treasury will sell 3-y, 10-y and 30-y notes. Evidently, MPC members from the ECB, the Fed and the BoE are now again free to give their give after recent policy decisions. Friday’s market reaction suggests that markets might be a bit cautious to already fully embrace the consequences of the Fed 5% message ahead of Thursday’s CPI release. Even so, the downside in yields (both in the US and Europe) should be well protected. Friday’s USD correction – EUR/USD rebound was remarkable. Still we expected the 1.00/1.0095 area to remain tough resistance. EUR/GBP sustainably trading above the 0.8781 neckline would be a positive for the cross rate/further negative for sterling.

News Headlines

•          The EU says the US is breaking WTO rules with its Inflation Reduction Act and warned it could lead to retaliatory measures from Brussels and other US allies. The IRA contains a $369bn package of subsidies and tax credits for green investments and products made in the US. The EU wants to change nine provisions that contain incentives that affect the manufacturing of products including solar panels, wind turbines and clean hydrogen. It said that if the Act gets implemented, it may result in inefficiencies and market distortions and possibly “trigger a harmful global subsidy race to the bottom on key technologies and inputs for the green transition”.
 
•          German finance minister Lindner has budgeted more than €83bn to finance energy price caps for gas (€40bn earmarked) and electricity (€43bn) in 2023, Reuters reported citing documents sent to budget committee lawmakers yesterday. It is part of the €200bn package to help households and businesses with their energy bills unveiled by German chancellor Scholz back in September. The plans are scheduled to run until spring 2024 and the total amount will be borrowed this year as Berlin makes use of the current suspension of the debt limit.

Graphs

The ECB ended net asset purchases and lifted rates by a combined 200 bps since the July meeting. More tightening is underway but the ECB refrained from guiding markets on the size of future hikes. Germany’s 10-yr yield rose to its highest level since 2011 (2.5%) before a correction kicked in. The neckline of the double top formation at 2.14% was tested but survived with ease.

The Fed policy rate was lifted by 75 bps to 3.75-4% in November and the central bank’s job isn’t done yet. But future hikes could be smaller from December or February on, depending on the data. Either way, the terminal rate is seen higher than projected back in September (4.5-4.75% early next year). Hikes are complemented by QT ($95bn/month). Market repositioning could allow for some further inversion of the curve.

EUR/USD tried to leave the strong downward trend channel since February but the move ended in tears. USD for the largest part of this year profited from rising US (real) yields in a persistent risk-off context. Geopolitical and European recessionary risks kept EUR in the defensive even as the ECB finally embraced on a tightening cycle.

The UK government had to backtrack on its lavish fiscal spending plans which sent sterling initially tumbling towards the EUR/GBP 0.90+ area. Yawning twin deficits and rising risk premia will continue to weigh on the UK currency longer term. In addition, the BoE signaled less rate support than markets currently assume. First resistance is located around 0.89.

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). Read the full disclaimer.

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