Thursday, 16 June 2022
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Markets

•          Yesterday didn’t bring the boring intraday countdown that often guides trading going into a Fed decision. After the recent sharp rise in yields and risk sell-off, investors scaled back on recent unidirectional positioning, whatever the outcome of the Fed decision. Yields corrected south. Equities tried a cautious rebound. Early in Europe, the ECB announced an ad hoc meeting to discuss current market conditions. The outcome of the meeting was meager. The ECB reiterated to apply flexibility in the reinvestment of PEPP redemptions. Staff was ordered to come up with a new antifragmentation instrument. The Italian 10-y spread vs Germany initially dropped more than 40 bps and preserved a big part of this gain even after a disappointing result. In the meantime, weak US retail sales further supported the bond rebound ahead of the Fed policy meeting. The Fed as expected raised the Fed Fund target by 75 bps to 1.50%-1.75%. In its projections/dots, it sees PCE inflation above 2% over the policy horizon (5.2% 2022, 2.6% 2023,2.2% 2024), with the median forecast for the policy rate seen at 3.4% and 3.8% end 2022 and 2023 respectively. Expected growth is downwardly revised to 1.7% this and next year. The unemployment rate is expected to rise from 3.7% to 4.1%. During the press conference, the Fed Chair reiterated that policy had to move into restrictive territory given the combination of excessive demand (also in the labour market) and restricted supply. Even so, if the Fed would be able to engineer the ‘Dots-scenario’, Powell said this would be close to a soft landing. On the short term trajectory for policy, Powel expects a 75 bps or 50 bps hike in July, but indicated that 75 bps isn’t a common move. He saw a rate at 3.0%/3.50% end 2022and 3.50%/4.0% next year as reasonable tightening to cool down demand. During the press conference, the decline in yields continued especially after his remarks that 75bps isn’t common. Finally, US yields dropped 23.6 bps (2-y) to 9.6 bps (30-y). Equities got some relief (Dow +1.0%, Nasdaq +2.50%). The dollar (DXY) jumped to a cycle top upon the announcement but dropped back to 104.80. In a similar move, EUR/USD spiked to the 1.10350/65 area, but the 1.0341 support wasn’t questioned. The pair closed at 1.044.

•          Today, markets will look for a new equilibrium post Fed. US yields, especially at the longer end might enter a consolidation pattern. (10-y: 3%-3.5%). The dollar remains well bid, but the pace of gains might slow, especially if equities would (temporary?) enter calmer waters, too. EUR/USD 1.0340/50 remains an key reference. The BoE will decide on monetary policy. Analysts expect an additional 25 bps hike, but maybe there is an outside risk for 50 bps, even as domestic demand is under pressure from the decline in real disposable income. If the BoE sticks to a 25 bps step, sterling probably will stay in the defensive. Also keep an eye at the Swiss national Bank (SNB)

News Headlines

•          The May Australian labour market report was decent, but near consensus. The unemployment rate stabilized at 3.9%, still the lowest on record. Employment increased by 60.6k following only 4.4k in April (influenced by Easter, school holidays, floods and ongoing Covid-disruptions). A positive trend in full time employment drives employment gains. In May, they increased by 69.4k, compensating for a 8.7k decline in part-time employment. The employment to population ratio increased to 64.1%, an all-time high and 1.6 percentage points higher than March 2020. Seasonally adjusted hours worked increased by 0.9%. A separate survey this morning shows consumer inflation expectations rising from 5% to 6.7% in June, the highest level since 2008. AUD/USD tries to hold above 0.70, following yesterday’s impressive rebound (from 0.6850) in a more relaxed global context.

•          New Zealand recorded negative GDP growth in Q1 (-0.2% Q/Q) coming from 3% growth in the final quarter of last year and below 0.6% Q/Q consensus. Net exports were responsible for the decline with exports down 14.3% Q/Q and imports decreasing by 2.8% Q/Q. Export of services fell 24.8% Q/Q and remains significantly impacted by the pandemic and continued border restrictions. Household spending held up, adding 4.6% Q/Q and being driven by spending on services. Real gross national disposable income did fall 0.5% Q/Q, reducing the consumer’s purchasing power. Investments in fixed assets rose 1.2% Q/Q but showed a mixed picture on a sector level. NZD/USD followed yesterday’s global move, bouncing off 0.62 support towards 0.63...
 

Graphs

Real yields took over from inflation expectations in pushing the German 10-yr yield beyond long term resistance at 1.13% (2012 & 2013 bottoms) to 1.24% (38% retracement on 2008-2020 decline). The next technical reference are 1.9% (50% retracement) to 2.09% (2013 high). The ECB finally turned the corner in its inflation narrative. The central bank will end net asset purchases this month, facilitating rate hikes from July.

The Fed started its tightening cycle and published an aggressive blueprint for the remainder of the year. A second 75 bps rate hikes in July is still on the table. Quantitative tightening will hit max speed by September. After a small correction in May, anticipation on even faster Fed tightening pushed the 10-y yield above the 3.2% (YTD high)/3.26% (2018 high) resistance. Intermediate resistance comes in at 3.76% ahead of the 4.0%/4.27 area (2010/2008 top)

EUR/USD tested the 2017 low at 1.0341 which survived. The pair (temporarily) rebounded mainly as the broader dollar rally took a pause. However, the 1.0806 resistance still proved one step too far, even as the ECB formally announced to start hiking rates as inflation stays unacceptably high. A persistent risk-off supports the dollar again. The 1.0341 area is again on the radar.

The developing cost-of-living crisis seems to hit the UK economy first and the hardest. Weak economic data toughen the Bank of England’s dilemma in battling inflation with doubts filtering through in markets. Open division within the BoE and the limited room for further tightening pushed EUR/GBP towards 0.872 resistance. A sustained break would further deteriorate the picture for sterling.

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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