• End of last week, investors concluded that EMU and US yields are discounting a ‘reasonable’ amount of tightening given the highly uncertain path for growth and inflation in the second half the year. US markets have incorporated the Fed’s dots scenario projecting a 3.4% policy rate end of this year and 3.8% next year. 2.25% is discounted for the ECB next year. These levels exceed what is commonly seen as the neutral rate. Above-neutral interest rates are ‘logic’ given the inflation overshoot. Still, as tightening will at least partially restore the demand-supply balance via lower demand, there was good reason for yield markets to move to a more neutral positioning, awaiting CB’s reaction function in case growth indeed were to slow down materially. With US markets closed, there was little ‘new news’ to guide this debate today. German May PPI inflation printed as expected at 1.6% m/m and 32.6% Y/Y (was 33.5% in April). If anything, the good news was it didn’t bring an upward surprise. Commodities including oil, copper and iron ore keep last week’s decline as investors ponder the impact of lower demand. European yields early in the session eased slightly, but the move was reversed later. German yields are rising op to 5.0 bps (5-y). The rise in natural gas prices to some extent complicates the narrative of potentially lower inflation due to lower demand (cf infra). European equities on average gain about 0.50%. Given recent sell-off, it’s much too early to label this as a rebound. Intra-EMU bond spreads show a mixed picture. France slightly underperforms after President Macron fails to secure a majority in Parliament (10-y spread vs Germany +3 bps). Greece (-7 bps) and Italy (-6 bps) narrow further as the ECB prepares an instrument to prevent market fragmentation.
• No clear trends on FX markets as the US markets are unable to give guidance (Juneteenth Holiday). The DXY index eases a few ticks (104.30). USD/JPY (134.95) is holding near last week’s multiyear peak. The yen struggles as the BOJ continues its lonely journey of more policy accommodation. The euro gains marginally (EUR/USD 1.051), but the technical picture hasn’t changed with first resistance at 1.0601 needed to be broken to open the way for a return to 1.0806 range top. Sterling cedes (modest) further ground (EUR/GBP near 0.858). UK CPI and retail sales (Wed/Fri) are next reference to assess chances for the BoE to step up the pace of rate hikes in H2. The Swiss franc continues to shine (EUR/CHF 1.014) after last week’s SNB interest rate hike, annex U-turn in its assessment on the valuation of the franc (no longer overvalued). In Central Europe, the zloty outperforms (EUR/PLN 4.66). The Czech koruna doesn’t profit (EUR/CZK 24.73) in the run-up to an expected (final) CNB jumbo rate hike on Thursday (100 or 125 bps).
• European gas futures extend an almost 40% rise last week by adding another 8% today. The Dutch gas future trades at €126/MWh, the highest level since mid-March when it shot up following the Russian invasion. The price surge relates to Russia cutting supply to top buyers including Germany, Italy and France, citing technical issues that prevent the pipeline from functioning. Nord Stream now operates at just 40% of capacity. The European Commission said Russia uses energy as “blackmail”. An outage at the Texas Freeport LNG plant, which made fewer cargoes available from the US that Europe counted on to restore reserves, adds to upward price pressures. Germany’s government already asked inhabitants to reduce consumption and said on Sunday it would pass emergency laws to reopen coal plants for electricity generation.
• US corporate bond funds saw billions of dollars flowing out last week, suffering a double blow from rising yields and mounting fears over an economic downturn as the Fed tightens to combat inflation. From the week to June 15, $6.6bn was withdrawn from high-yield bond funds, the FT reported using EPFR data. It was the biggest outflow since the big sell-off in March 2020 and brings the YTD amount already to almost $35bn. Funds that buy investment-grade bonds saw an outflow of $2.1bn that week, the biggest weekly withdrawal since April 2021. CDS spreads (high-yield vs investment-grade) have risen from multiyear lows mid-2021 to almost 500 bps – the highest level since May 2020.