Tuesday, 24 May 2022
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•          Markets’ mood/reaction function continue switching sides from day to day. Last week, uncertainty that policy tightening could kill growth, triggered hefty equity selling and a pause in the core yields’ rally. Yesterday, investors saw the glass again half full hoping a recession could be avoided. The trigger wasn’t that obvious. President Biden indicating the US might reconsider the import levies on Chinese goods maybe helped. German Ifo business confidence was better than expected but had limited direct impact on markets. Still, US and European equities gained between 1.40% (EuroStoxx 50) and almost 2.0% (Dow).  The risk-on this time coincided with a substantial rebound in core yields. In Europe, the focus was on a blog of President Lagarde at the ECB website. Lagarde concluded that the era of inflation structurally undershooting the target probably ended, allowing the ECB to start policy normalisation. She rubberstamped the scenario of ending APP early Q3 with a rate lift-off in June and the ECB exiting negative rates at end of Q3. For markets, this brings clarity on the start of ECB normalisation. Even so, this scenario was largely discounted. It’s also a bit strange for the ECB president to bring this guidance a week before the publication of EMU inflation data and frontrunning new staff forecasts at June 9 meeting. Didn’t the ECB advocate data dependency? In this respect, the move probably also aims to sooth the debate on bigger ECB steps. The first reaction on EMU interest rate markets was modest, but EMU yields later followed the broader trend. The German yields finished 7-8 bps higher across the curve. The US curve steepened with the 2-y rising 2.7 bps and longer maturities rising 6.5/7 bps. The (trade-weighted) dollar remained in correction mode. DXY dropped a full big figure to close in the low 102 area. Even as the ECB blog was a bit ambiguous, it propelled EUR/USD above the 1.0642 short term top (close 1.0691). EUR/GBP followed at similar trajectory closing near the 0.85 big figure.

•          This morning, sentiment in Asia again turns more cautious despite China announcing a 33 points package to support the economy. Asian equities are ceding between 0.70% (Nikkei) and 1.5% (Chinese indices). The dollar regains a few ticks. Treasury yields decline slightly. Later today, the PMI’s will provide an update on the health of the economy in EMU, the UK and the US. For Europe, the composite PMI is expected to ease from 55.8 to 55.1. Maybe the message of the PMI’s shouldn’t be that negative. Recent data on current activity weren’t that bad. Markets will also look out for signs of price pressures reaching some kind of peak. Even so, global sentiment will remain an important driver for trading. Equity futures suggest that yesterday’s equity rebound still might turn into a new sell-on upticks move. This might cap a further rise in core yields, confirming recent consolidation pattern on (EMU and US) interest rate markets. On FX, we look out whether the dollar correction continues. Will EUR/USD be able to hold north of the 1.0642 resistance? If so, the 1.0758/1.0806 area (previous lows) will become next reference on the charts.

News Headlines

•          The Federal Reserve’s overnight reverse repurchase facility hit a new milestone, with banks and money market funds parking more than $2tn on Monday for the first time. It’s a sign of a still massive amount of excess liquidity even as the Fed started raising rates and will shrink the balance sheet from next month on. Technical elements are at work too. US Treasury bills are a popular alternative for cash but Treasury has cut issuance in recent months as solid tax collections and a drop in government spending have reduced the need thereof. Increased competition for T-bills increases its prices, lowers yields and makes investors look for other (safe) options, such as the Fed’s RRP.

•          Russia’s finance ministry announced it will ease more capital controls amid a surging ruble. The share of FX proceeds that exporters are required to sell will be lowered from 80% to 50%, citing “the stabilization of the exchange rate and the reaching of adequate levels of foreign-currency liquidity on the domestic market.” With the Russian currency now about 30% stronger than the US dollar compared to before the invasion (USD/RUB <60), it risks hurting budget revenue and its (energy) exporters. Aside from capital controls, the strong ruble is also the result of western sanctions having led to collapsing imports lowering demand for foreign currency while its supply surges due to Russian energy exports. The Russian ministry is also referring to future rate cuts to ease pressure on the ruble.


The ECB will end net asset purchases in June. A first rate hike is likely in July (or even June?!). Speculation has caused real yields to bottom out. Inflation expectations, while still high, are correcting lower from record highs. The worrying growth outlook complicates the picture and triggered a first meaningful correction since the start of the Russian invasion. Support at 0.80% stood firm. The German 10-y yield returned to the 1.0%.

The Fed started its tightening cycle and published an aggressive blueprint for the remainder of the year. 50 bps rate hikes at the next meetings can be taken for granted. Quantitative tightening will start in June and hit max speed from September onwards. But the recent yield surge this caused, has eased recently. Yields may be entering a period of consolidation. Important support is located at 2.72%.

EUR/USD lost the previous YTD low at 1.0806 and the 2020 bottom at 1.0636, worsening the technical picture. At first, the ECB flagging the rate lift-off in July didn’t help much. However, the 1.0341 2017 low survived. The pair regaining 1.0642 in a sustainable way would be a first sign of easing downside momentum.

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 temporary above the 0.8512 level. A sustained break would be a bad omen 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).
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