Risk appetite is stronger overnight, with large gains in both European and US equity markets (S&P500 +2.5%). The EUR is almost 1% higher while European rates have increased after reports the ECB will consider a 50bps hike at this week’s meeting and announce its anti-fragmentation tool for supporting peripheral bond markets. The NZD has appreciated in sympathy with the EUR, breaking through the 0.62 mark overnight.
The EUR has continued its recent recovery while European short-term rates have spiked higher after a Reuters report that the ECB will discuss a 50bps hike at its meeting later this week. The ECB had previously signalled a 25bps move at this meeting, albeit with President Lagarde providing herself with a little wiggle room for a larger move if required. The ECB sources said that no decision had yet been made but the debate would be between a 25bps hike and a 50bps move.
The market has moved from a strong consensus that the ECB will hike by 25bps later this week to now be around 50% priced for a 50bps move. The German 2-year rate was 12bps higher, to a three-week high of 0.64%, while there has been some spill over to other bond markets, the US 10-year rate up 3bps overnight to 3.02%.
The Reuters report also said the ECB will announce its anti-fragmentation tool, designed to support vulnerable peripheral government bond markets like Italy’s, with countries needing to meet European Commission targets to participate. Italy’s 10-year bond spread to Germany narrowed only marginally, with investors seemingly waiting for the full details of the scheme to be announced. The anti-fragmentation tool comes at an important juncture for the European bond market, with Italy experiencing another bout of political turmoil after PM Draghi offered to resign late last week. Draghi is due to address parliament tonight amidst reports of further fractures in his coalition government, with the right-wing League and Forza Italia parties saying they would no longer work with the Five Star party.
Meanwhile, Reuters reported that Gazprom would restart gas flows through the Nord Stream 1 pipeline on time when the annual maintenance period ends later this week, but, importantly, still at reduced capacity, the Russian energy firm having previously blamed a broken turbine for reduced supply.
The EUR is up almost 1%, building on yesterday’s strong rally, and has broken through the 1.02 mark, now 1.0230. In addition to the repricing of ECB rate expectations, unwinds of consensus short positions in EUR have likely played a part in the recent correction. The USD is broadly weaker against a backdrop of EUR strength and better risk appetite, the BBDXY index down around 0.5% for the third day running and now about 2% off its recent multi-year high.
The NZD has appreciated strongly in sympathy with the EUR, to which it has been highly correlated in recent times, moving from around 0.6160 this time yesterday to 0.6220 this morning, a gain of around 1%. Overnight, the GDT dairy auction saw a 5% fall in the price index (5.1% for whole milk powder), the eighth fall of the past nine auctions.
In the UK, Bank of England Governor Bailey flagged a possible 50bps rate hike next month, saying “a 50 basis point increase will be among the choices on the table when we next meet” given upside inflation risks, while adding that the committee hadn’t made a decision yet. There hasn’t been much market impact from Bailey’s comments with the market already close to fully-pricing such a move, the GBP underperforming overnight, up 0.4% to just below 1.20.
Equities have rebounded strongly overnight, continuing their tentative recovery since the shocking US CPI report last week. The S&P500 is currently up 2.5% and the NASDAQ almost 3% overnight, following a similar-sized increase in the German DAX. Recession fears certainly haven’t gone away and the rebound in equities over the past week could as much reflect a recovery from oversold levels and extreme levels of pessimism. To this point, Bank of America’s closely watched Fund Manager Survey showed investors’ equity allocation was its lowest since the GFC while cash levels were at a more-than 20-year high, indicative of a very cautious stance towards risk assets. When investor sentiment reaches bullish or (in this case) bearish extremes, it sometimes leads to a contrarian reversal.
In corporate earnings, Johnson & Johnson and IBM both beat earnings expectations but the market focused on the firms’ downgrades to earnings and cash flow projections for this year, due to the stronger USD detracting from foreign earnings. Netflix reports after the bell this morning, the first of the major tech names to release its results.
Economic data released over the past 24 hours has been second tier and not market moving. Both US building permits and housing starts fell in June, the latter by more than expected, as the housing market starts to soften in the wake of the sharp increase in mortgage rates.
In Australia, the minutes to the RBA’s July policy meeting and RBA Deputy Governor Bullock’s speech yesterday were seen as hawkish, contributing to a 10bps increase in the 3-year Australian bond rate. The cash rate remains a long way below ‘neutral’, and the central bank’s initial aim appears to be to remove stimulatory conditions reasonably quickly given the extremely tight labour market and intense inflationary pressures. RBA Governor Lowe is speaking this morning, with the market pricing around a 30% chance of a 75bps hike for next month’s meeting, but the key event ahead of the next rate decision is next week’s CPI release.
NZ rates were higher yesterday, taking their lead from offshore markets. The yield curve snapped steeper, bucking its recent flattening trend, with the 10-year swap rate increasing by 9bps while the 2-year rate was only 2bps higher. Despite yesterday’s sharp steepening move, the 2y10y curve remains deeply inverted, at -19bps, a sign the market thinks the RBNZ is going to overdo the tightening cycle.
The UK and Canada release their CPI reports tonight, with both expected to show fresh multi-decade highs in annual headline inflation. The key event tonight is likely to be Italian PM Draghi’s address to parliament and whether he reiterates his resignation decision or suggests an openness to continuing as PM.
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.