Thursday, 27 October 2022
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Markets

•          This week’s correction higher in core bonds continued yesterday. The Bank of Canada’s decision to “only” hike by 50 bps (see below) added to the case that the Fed could do the same from December against the backdrop of disappointing eco data and weak corporate earnings (including pessimistic outlook). US yields lost 7.3 bps (2-yr) to 12 bps (30-yr) in a daily perspective. The US 10-yr yield tests the psychologic 4% support. German yields shed 2.5 bps (2-yr) to 5.8 bps (10-yr) with the belly of the curve outperforming the wings. The German 10-yr yield is giving away the neckline of a short term double top formation at 2.14%, implying a return lower towards the 1.82% (38% retracement on upleg since early August)/1.77% (October low)/1.74% (final target double top formation) support zone. The easing of tensions on the core bond market also translated in a dollar correction. EUR/USD yesterday managed to exit the downward trend channel in place since February. A sustained break in this week’s close makes the technical picture neutral, with EUR/USD 0.9536/1.0350 turning into a new, sideways trading range. The trade-weighted dollar (DXY) lost support at 110.06 (neckline double top). September and August lows respectively stand at 107.68 and 104.64. USD/JPY closes in on the 145 big figure. US stocks underperformed European ones on disappointing tech earnings (Nasdaq -2%).

•          It’s all about the ECB today. Money markets agree a 75 bps hike but are split on the December outcome between 50 bps and 75 bps. We side with the latter. As long as labour markets stand strong, we see no reason for the ECB to decelerate its tightening efforts already despite weak growth momentum. Key policy rates aren’t in neutral territory yet, let alone restrictive. Money markets put the ECB policy rate peak level at 2.75%-3% by mid next year which we think is way too conservative. The ECB will also communicate on the structure of outstanding TLTRO’s. The central bank wants to by-pass that cheap loans granted during previous crisis years get rerouted to its own deposit facility. Sources suggest that three possible options remain. The first and most simple one is unilaterally changing the terms of the TLTRO’s so that cash from the operations would not be remunerated at the deposit rate. A second possibility consists out of treating TLTRO cash in the same way as minimum reserves, which are currently remunerated at 0.5%, below the 0.75% deposit rate. The final solution is some sort of reverse tiering that would allow for a more favourable remuneration up to a certain threshold, after which a lower rate would apply. The ECB could indicate that it is working on a plan to wind down its asset portfolio APP (+-€3.2tn). From a market point of view, we think the hawkish ECB stance will further support the euro. On bond markets, we deem chances on new sustained sell-off smaller given overall market climate unless the ECB pre-commits to another 75 bps in December.

News Headlines

•          The Bank of Canada raised rates from 3.25% to 3.75% yesterday. The 50 bps increase was less than the 75 bps in the previous meeting and less than anticipated. The BoC struck a mixed tone, saying the economy continues to operate in excess demand and labour markets remain tight, putting upward pressure on domestic inflation. Headline inflation eased over the past months and should return to the 2% target in 2024. But core measures are not yet showing meaningful evidence of easing. Effects of earlier tightening are dampening housing activity and household and business spending though while the slowdown in international demand is beginning to weigh on exports. Growth was revised lower to 2.1% in 2022, 1% next year and 2.3% in 2024. The BoC expects that rates will need to rise further given elevated inflation (expectations). Canadian swap yields tumbled more than 25 bps at the front end after the decision. Money markets adjust the expected terminal rate lower from 4.5% to 4.25%. Thanks to overall USD weakness, the damage for the loonie remained contained. USD/CAD even finished lower at 1.355.

•          South Korean growth slowed as expected from 0.7% q/q to 0.3% in Q3. Its economy is now 3.1% bigger than one year ago. From the previous quarter, private consumption rose 1.9%. Exports advanced 1% but were more than offset by a 5.8% rise in imports. This helps explain the weak KRW performance, which drives up imports/energy costs further and exacerbates inflation. It is also the reason why the BoK will stick to its tightening path, despite decelerating growth. It raised rates by 50 bps at the latest occasion, to bring the policy rate at 3% currently. The won advances against the USD this morning, but that’s mainly on general dollar weakness (again).

Graphs

The ECB ended net asset purchases and lifted rates by a combined 125 bps at the July and September meetings. 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. Losing the neckline of the double top formation at 2.14% calls for a return towards the 1.82%/1.77%/1.74% support zone.

The Fed policy rate entered restrictive territory, but the central bank’s job isn’t done yet. The policy rate is expected to peak above 4.5% early next year and remain above a neutral 2.5% over the policy horizon. QT hits max speed. The 10y reached its highest level since 2007. Doji on the charts suggests room for short term correction with some Fed members calling to slow the tightening cycle.

EUR/USD is leaving the strong downward trend channel since February. 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 current correction on bond markets weighs on USD as well. KEY resistance stands at 1.0350.

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 even as markets think that the BoE will have to step up its tightening cycle.

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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