• The (mostly) European inspired recession trade that dominated trading since end last week finally took a breather as the market focus is turning to this evening’s Fed decision. European data at least didn’t provide much comfort. German GFK August consumer sentiment dropped further to a record low (-30.6 from 27.7) as consumers pondered whether there will enough gas this winter. Sentiment indicators in Italy and France also show growing pessimism among businesses and consumers. For now, there are few indications that uncertainty on Russian gas supplies will be resolved any time soon. The reference Dutch gas contract again touched a new peak since March (€ 222.5 MWH) before easing modestly. Despite lingering fears on a sharp deterioration in EMU economic activity, German yields bottomed, at least temporarily, after recent sharp decline. German yields ‘regain’ between 1-2 bps. On intra-EMU bond markets, Italian bonds again underperform (10-y spread vs Germany +6 bps) after S&P yesterday evening changed the outlook on the Italian BBB rating from positive to stable (cf. infra). US data mostly were stronger than expected. The US June trade deficit narrowed to $98.2 bln from $104 bln. US durable goods orders unexpectedly jumped 1.8% M/M. Even as the rise was supported by defense aircraft orders, core capital goods shipments (used to calculate investments in the GDP report) also rose a solid 0.7%. The data are supportive for tomorrow’s Q2 GDP release. Still it had little lasting impact on (bond) markets. US yields even decline up to 5 bps (5-y). Equity markets are in better shape today, supported by solid earnings from US bellwethers. European equities again up to 0.75/1.0%. US indices open with gains of up to 2.0% (Nasdaq). Moves in most major USD cross rates remain very limited. The DXY USD index declines marginally (107.5). EUR/USD hovers in the 1.0150 area. EUR/GBP tested the 0.84 area, but no break occurred (currently 0.8425).
• The most important topic for global trading today evidently is this evening’s Fed decision. Anything different from a 75 bps trade hike to 2.25%/2.50% would be a huge surprise. Investors will be keen to get insights on the pace of the hiking cycle in September and beyond. Fears for a slowdown recently lowered expectations for Fed hiking to come to an end around the turn of the year near 3.25%/3.5%. We’re not convinced that Powell will already signal the Fed to sharply slow its anti-inflation campaign in the near future as inflation remains elevated and the labour market stays hot. As recent repositioning was mainly driven by risks to growth rather risks to persistent high inflation, a balanced Fed message might slow the setback in yields. Such a scenario would also help to put a floor for the USD.
• The leaders of Italy’s right-wing bloc are meeting this afternoon to agree on how to pick the country’s new prime minister should they win the elections on September 25 as polls currently predict. The gathering takes place against the backdrop of S&P having lowered Italy’s outlook from positive to stable. The rating agency said Draghi’s resignation and the prospect of early elections risk shifting the “focus away from key reforms and further weigh on confidence and growth at a time of high uncertainty and rising inflation.” Under an informal rule, the party that gets the most votes picks a new PM. According to a most recent poll, this would be Meloni of the Brothers of Italy party (23.4%). But the League and Forza Italia are resisting this. Italian bond underperform today following the S&P downgrade. The spread vs. Germany’s 10y yield is at 236 bps, the highest since mid-June.
• Sunak, one of the two remaining candidates to become the UK’s next PM, dramatically changed his view on tax cuts. In a surprise announcement today, Sunak said he would scrap the VAT on domestic energy bills if he wins. Going into the leadership contest, he defended his fiscally conservative approach as being essential to fix public finances and not to stoke inflation even further. His opponent, Truss, on the other hand hinted at a raft of immediate tax cuts should she become PM. The Secretary of State is leading by a big margin in polls of party members.