The Markets
The November rally in core bonds continued yesterday, but in contrast to Wednesday they closed off the intraday highs. A dovish tone from the Bank of England and disappointing Q3 US unit labor costs (-0.8% q/q with upward revision to Q2: 3.2% from 2.2%) set the tone.
Equity markets rallied in lockstep, with major European indices closing 1.5% to 2% higher and major U.S. benchmarks posting similar gains.
The EUR/USD moved from an open of 1.0570 to a close of 1.0622. Daily changes in the US yield curve ranged from +4.6 bps (2yr) to -12.7 bps (30yr). The US 2yr yield tested the October low (4.92%), which is the neckline of a double top formation, but bounced off this level. Similar support in the US 10-yr yield stands at 4.58% (vs. yesterday’s close of 4.66%). German yield differentials ranged from +2 bps (2-yr) to -6.9 bps (30-yr).
The German 10-yr yield tested the same double top formation (with the October low of 2.68% as neckline), but a break lower didn’t happen. UK Gilts outperformed with yields closing 6.2 bps (2-yr) to 11.6 bps (7-yr) lower as the belly outperformed the wings. The Bank of England’s split decision to hold rates rather than hike was less narrow than in September (5-4 vs. 6-3), with the updated Monetary Policy Report showing little growth over the policy horizon.
The Pound initially weakened from EUR/GBP 0.8690 towards 0.8735, but closed nearly unchanged at 0.87. From a technical point of view, the pair is unable to make much headway beyond 0.87-0.8750.
Today’s calendar is focused on the US payrolls and services ISM. The consensus is for 180k net new jobs, a stable unemployment rate (3.8%), wage growth of 0.3% M/M & 4% Y/Y, and the ISM ticking back from 53.6 to 53. Given the recent bond correction, we see asymmetric risks with markets rallying (& dollar weakening) on weaker or in-line data. It will likely take a big upside surprise on both to send bonds and equities lower again.
After this week’s FOMC meeting, the first Fed governors will speak (Barkin, Kashkari, Bostic) and serve as a wild card. ECB‘s Schnabel has already said that the central bank can’t close the door on further rate hikes. “After a long period of high inflation, inflation expectations are fragile and renewed supply-side shocks can destabilize them, threatening medium-term price stability.” She added that it took a year to get inflation from 10.6% to the current 2.9%, but that the ECB expects it to take about twice as long to get back to 2% from here.
News and Views
The Czech National Bank left its key interest rate unchanged at 7% yesterday in a 5 (hold) to 2 (cut) vote. Markets and analysts believed that the central bank would have started the cut cycle with a 25 bps move. The risk of unanchored inflation expectations remains, the CNB said. “This risk could manifest itself in the outcome of the ongoing wage negotiations and in a stronger-than-expected repricing of goods and services at the beginning of next year.” While price pressures have eased dramatically, they remain too high. In particular, core inflation is a cause for concern, with an outlook of 3% on average through 2024. The decision was made even as economic growth was being cut.
It’s overshadowing a weakening economy that unexpectedly contracted in Q3. The CNB expects -0.4% this year before returning to growth of around 1.2% next year. The central bank added that the depreciation of the krone has led to a slight easing of overall monetary conditions. It added to the case for keeping interest rates where they are. The Executive Board has discussed a strategy for future rate cuts and expects that any reduction will initially be moderate and gradual.
With its internal models projecting a 50 bps cut by the end of this year, “the interest rate path in the coming quarters is therefore likely to be higher than in the baseline scenario of the forecast.” KBC Economics expects a rate cut of 25 bps (to 6.75%) in December, although the risks are tilted to an even later start of easing. The Czech koruna rallied on the hawkish policy outcome. EUR/CZK fell from 24.66 to 25.45. Czech swap yields decoupled from the global and local trend yesterday, rising 10 bps at the short end of the curve.
