• Higher-than-expected German inflation hit double digits (10.9%) and UK PM Truss defended the lavish fiscal stimulus plan despite huge market turmoil. Those two themes defined European trading in the way that feels very familiar by now, i.e. a stronger dollar, surging core bond yields and tumbling equities. The latter held for the rest of the day with the EuroStoxx50 closing at a new YtD low (-1.7%). Wall Street finished between 1.5 and 2.8% lower as Fed members including Daly, Mester and Bullard once again made clear that tightening continues, period. The USD strengthening however faded during US dealings. Trade-weighted (DXY), the greenback eased from intraday highs of 113.79 to 112.25. EUR/USD and GBP/USD swapped losses for gains to close at 0.981 and 1.11 respectively in what was at least as much (if not more) a euro and pound rebound as the dollar dwindling. EUR/GBP tumbled to 0.883. Core bond yields closed below their intraday highs. The European short-end outperformed. The 2y German yield shot up 9 bps after the inflation release but finished 5 bps lower. The 10y only retained 6 bps at a 18 bps intraday rise. The US yield curve flattened with changes between 5.9 bps (2y) and 2.6 bps (30y). UK yields halved gains to a still-sizeable 10.3-14.2 bps in the 2y-10y segment. The 30y rose 3.3 bps. The BoE bought £1.4bn in its emergency Gilt operation.
• The grim US stock session ripples through Asian markets with the biggest losses for Japan (-2.15%). The US dollar appreciates marginally on FX markets. Sterling outperforms after UK PM Truss and Chancellor Kwarteng will hold emergency talks with the OBR today before the latter publishes a first draft of fiscal forecasts next week. Markets hope it opens the administration’s eyes. Coincidence or not but the idea came after a YouGov poll gave the Labour Party a 33-point lead over the Tories. It’s the biggest gap since the nineties. Core bonds in any case cautiously inch higher. Economic data is mixed and limited to unconvincing Chinese official PMIs.
• We keep a close eye at the European September inflation figure today. Expectations are for a rise to 9.7%. National readings from Germany and Spain (slowed to 9.3%) yesterday provided contradicting clues. Judging yesterday’s market reaction though, we stick to the idea of short-term consolidation. Big short positions in core bonds as well as the euro and sterling may also be partially unwound amid quarter-end reshuffling. We still fear for equities though, especially with Rssian president Putin’s annexation speech that is due later today. The EuroStoxx50 risks breaking through support from the downward sloping trendline connecting the January, March and April highs. The S&P500 yesterday re-tested the June lows.
• The Czech National Bank yesterday as expected left its two week repo rate unchanged at 7.0% in a 5-2 (+75 bps) vote. The CNB indicates that interest rates are currently at a level that is dampening domestic demand pressures. As the CNB stays committed to bring inflation back to the 2.0% target, interest rate are expected to remain relatively high for some time. The CNB still expects inflation to potentially reach 20% in the autumn, but forecasts it decline to 2.0% in a year and a half. Long-term price stability is also contingent on moderate wage bargaining demands and responsible fiscal policy. In this respect, the CNB Board will further assess data. It will decide at the next meeting whether rates will remain unchanged or increase. The Czech National Bank will continue to prevent excessive fluctuations of the koruna (via FX interventions). After testing the EUR/CZK 24.70 barrier earlier in the session, the korona rebound substantially post-CNB to close at EUR/CZK 24.53.
• The London Metal Exchange (LME), after speculation in the media, in a statement indicated that is considering a consultation on the ongoing acceptability of Russian metal in the broader physical market. However, the LME clearly indicated that no decision has yet been taken whether to launch the discussion paper. The statement came after Reuters reported that three sources indicated that the LME was planning to discuss banning new deliveries of Russian metal so its warehouses cannot be used to offload hard-to-sell stock. The debate yesterday triggered some additional volatility in the prices of the likes of aluminium and nickel.
The ECB ended net asset purchases and lifted rates with a 50 bps inaugural hike and a 75 bps follow-up move. A similar-sized move in October is in the cards. Germany’s 10-yr yield broke out of the corrective downward trend channel since mid-June and took out the YTD high at 1.93%. In case of a sustained break, 2.56% serves as the next reference. Short-term though we expect some sideways consolidation.
After three 75 bps rate hikes, the Fed moves into (modestly) restrictive territory, but more rate hikes are needed to slow aggregate demand. After a sharp correction this summer, the 10y breaks beyond the 3.50% barrier. With the Fed signalling a prolonged period of restrictive policy, next target at 3.76% was hit quickly thereafter. 4.0% was tested but survives for the time being.
EUR/USD is in a strong downward trend channel since February. A hawkish ECB did no more than buying the euro some time. The dollar remains the main beneficiary of rising US (real) yields combined with a persistent risk-off context. Geopolitical tensions and the risk of a recession don’t help the euro either. The break below 0.9864 opened the way to the psychological 0.95 mark.
The Bank of England hiked by 50 bps in September but risks falling behind the curve with lavish fiscal support. Markets aggressively repositioned in response. The pound is unable to profit from this increased rate support though with attention going to yawning deficits and rising risk premia. EUR/GBP skyrocketed above 0.90. Sterling’s faith is sealed if the Truss administration does not pivot on the overambitious fiscal plans.
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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