Monday, 29 August 2022
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Markets

•          Markets pondering Fed Powell’s assessment on monetary policy dominated trading throughout the whole of last week. It took Powell less than 10 minutes to clarify Fed’s intentions going forward. The Fed’s focus continues to be on bringing inflation back to 2.0% and its aim to do so is unconditional. In the respect, the Fed will do its part to bring supply and demand back into balance. Policy will have to be sufficiently restrictive. This probably will translate into a period of sub-trend growth and cause some easing of current very tight labour market conditions. However, this price needs to be paid to prevent persistently high inflation causing more damage. History illustrates that a delay in the policy response only raises the cost for employment. The Fed decisively intends to keep inflation expectations well anchored. Powell also clearly indicated that policy probably will have to remain tight for quite some time. A discussion on rate cuts is currently highly inappropriate. US interest rates evidently jumped higher in the wake of Powell’s straightforward message. However, the reaction could have been bigger. Of course, (US) yields last week had already repositioned for a hawkish guidance. The US 5y and 2y yield respectively closed 5.3 and 3.0 bps higher. In a further flattening trend the 30y lost 4.9 bps. The most forceful reaction occurred on equity markets. US indices lost up to 3.94% (Nasdaq). The Fed deliberately slowing aggregate demand is no good news for growth-sensitive assets. The dollar post-Powell reversed an initial intraday setback. Still, here too, gains could have been bigger. DXY closed the day only modestly  higher at 108.8. EUR/USD, which jumped well north of 1.005 in in the run-up to Powell’s speech, also closed little changed at 0.9966. Euro losses were at least partially mitigated by a flood of hawkish headlines on ECB policy. A Reuters report, citing sources with knowledge of the internal debate within the ECB, indicated that several policy makers want to discuss a 75 bps rate hike at next month’s meeting. This was later confirmed by comments from the likes of ECB’s Kazaks, Schnabel, Villeroy and Knot. Some ECB members apparently also want to start the discussion on shrinking the ECB balance sheet already before the end of this year. German yields rose between 11.4 bps (2-y) and 1.6 bp (30-y).
•             Asian markets this morning are in an outright risk-off modus in the wake of Powell’s comments on Friday (Nikkei -2.50%). After a modest reaction on Friday, US yields are now rising up to 7 bps for shorter maturities. The broad risk-off repositioning also fully allows the dollar to fulfill its safe have role. The DXY index tries to overcome the 109.30 June top. EUR/USD (0.9935) is drifting back lower in the 0.99 big figure. The eco calendar is extremely thin today. However, this probably won’t prevent the trend of weaker equities, a strong dollar and a bear flattening of the yield curves to continue. 

News Headlines

•          Czech National Bank governor Michl wrote in a blog on the CNB-website that inflation is unlikely to be persistent as declining real income will probably curb household consumption. Monetary policy is already in restrictive territory (policy rate: 7%) and is helping to curb demand. Czech interest rates will remain at elevated levels in the coming quarters. He doesn’t exclude a potential rate hike at the next meeting, but says that rates alone won’t cure inflation. Earlier in the weekend, a CNB vice governor said she favoured an EU energy price cap over a Czech windfall tax while warning against large wage hikes. The government recently agreed a 10% salary boost for some sectors. EUR/CZK holds near 24.65 thanks to continued FX interventions by the CNB, preventing an unwelcome decline in the currency.
•          National Bank of Poland governor Glapinski told Business Insider that the NBP will probably raise its policy rate (currently 6.5%) once or twice by an additional 25 bps. Such smaller rate hike would signal that the cycle is slowing down. Personally, he’d even consider stopping the tightening cycle completely as inflation is expected to slowdown in coming months. A spike in the January 2023 reading because of an increase of regulated prices, shouldn’t influence monetary policy. Glapinski thinks that a first rate cut should be possible in Q4 2023. The Polish zloty remains rather weak around EUR/PLN 4.75. The global environment (big central banks stepping it up and hurting risk sentiment) plays in the currency’s disadvantage, especially should the NBP simultaneously slow it down.

Graphs

The ECB ended net asset purchases and lifted rates with a 50 bps inaugural hike. More tightening is underway. Even a 75 bps hike might be on the table at the September meeting. Germany’s 10-yr yield broke out of the corrective downward trend channel since mid-June, suggesting more upside short term.

The Fed hiked to neutral by a back-to-back 75 bps in July. The size of future moves depends on the incoming data. QT will hit max speed by September. The 10y briefly dropped below the lower bound (2.70% area) of the sideways trading range, but a sustained break lower was averted. The focus is back on central bank frontloading to tackle inflation.

The euro zone’s (energy) crisis is being accompanied by an Italian political crisis, weighing down the euro. Hawkish Fed comments going into the Jackson Hole gathering and the simultaneous sell-off in bonds & equities push the euro to new lows below parity. This year’s downward trend channel suggests more downside.

Sterling’s strong run going into the BoE meeting of August abruptly ended. The central bank hiked by 50 bps. More hikes are likely given stellar inflation, but have been priced in already. Combined with the BoE’s grim economic assessment it triggered a profit-taking move. EUR/GBP is trying to exit the corrective downward trend channel since mid-June.

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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