• US investors returned from a long weekend and immediately left a stamp on trading. Especially equity markets were in good shape. Main indices jumped between 2.15-2.51%. European equities had to settle for <1%. The improved sentiment filtered through in core bond markets. US Treasuries underperformed German Bunds in a catch-up move. The US curve steepened by adding 1.6 bps at the front-end (2y) to 5.7 bps further out (20y). German yields rose 2.2-3.4 bps in the 10y-30y bucket. Both closed at a new cycle high. Peripheral spreads vs. Germany’s 10y continued to narrow for the likes of Italy (-3 bps) and Greece (-10 bps) amid excitement for the ECB’s yet-unknown new anti-fragmentation policy tool. The Japanese yen felt pressure from global sentiment and the BoJ sticking to its easing guns. USD/JPY surpassed the 135 resistance zone (2002 top) to close at 136.57, the highest in 24 (!) years. EUR/USD enjoyed a decent bid but lost momentum as (US) trading developed. The pair closed a little higher at 1.053. Bank of England chief economist Pill said he’s willing to sacrifice growth to cut inflation. It’s posing sterling for a difficult trade-off between tempting interest rates (Gilts underperformed yesterday) but an increasingly gloomier economic picture. EUR/GBP simply decided to stay put (close at 0.858, unchanged).
• The Asian stock bounce yesterday already goes into reverse today. We’ve seen no specific trigger or concrete news, confirming our view of a sell-on-upticks market. South Korea is lagging with losses amounting to 3.5%. Core bonds, the dollar and the Japanese yen attract safe haven bids. The trade-weighted greenback (DXY) advances to 104.70. USD/JPY gives up a slight part of yesterday’s gains. EUR/JPY (142.95) changes course after hitting the 144 resistance area/cycle high yesterday.
• EMU consumer confidence (June) is due today but the main focus will go to Fed chair Powell’s testimony before the Senate. The text released on Friday highlighted the Fed’s “unconditional” commitment to restore price stability. We don’t expect the tone before Congress to differ much from that or from the policy meeting last week. The actual grilling by Congress members could be interesting though. Will political attention already shift a bit from growth or is it too soon with surging prices dominating the political discourse going into the November mid-terms? Whatever the outcome, risk sentiment will probably prove the market theme for today anyway. UK inflation in May couldn’t be more close to expectations, coming in at 0.7% m/m to be up 9.1% y/y, slightly higher than last month (9%). Core inflation edged down a bit more than anticipated, to 5.9%. The numbers justify last week’s message by the BoE to raise rates faster if needed.
• Italian Foreign Minister Luigi Di Maio on Tuesday announced that he’s leaving the 5-Star Movement. He will form a new parliamentary group. The split in the 5SM comes as the party is internally highly divided on the support of Italy for Ukraine. 5SM leader Conte recently became ever more critic on Italy sending weapons to the country. At the same time, Di Maio doesn’t want to break ranks with PM Draghi’s supportive policy towards Ukraine. There is growing speculation recently that Conte wants the 5SM to leave the government coalition as the party is losing support in the opinion polls, but the party yesterday dismissed this. It is unsure how many how many 5SM members will join Di Maio. For now the split doesn’t cause an immediate danger to the majority of PM Draghi’s government. Even so, it is not good news for the stability of the coalition ahead of next year’s elections.
• US existing home sales data yesterday provided a mixed picture. Sales dropped for the fourth consecutive month (3.4% M/M) to the lowest level since June 2020 as mortgage interest rates continue to rise. At the same time, the median average selling price for the first time rose a record north of $400 000 (+14.8% y/y). Higher prices and higher mortgage rates are making houses less affordable for new buyers. At the same time, prices still are supported by a very low inventory levels of houses for sale. Earlier this month housing starts and building permits data already showed a loss of momentum.
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. For now the 3.5% looks to provide strong resistance
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. The persistent risk-off that supported the dollar has receded somewhat, alleviating immediate downward pressure.
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. The BoE in June signaled it might step up tightening, but it is unsure whether this will change fortunes for sterling.
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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