The Markets
Markets got off to a choppy start yesterday, suggesting that the bond-inspired everything rally is losing steam. A back-loaded economic calendar is also keeping investors at bay. US yields recovered 2.1-9.6 bps from last month’s huge losses. The front end underperformed. German yields lagged, but still closed off intraday lows. Changes ranged from -0.8 bps (10y) to +1.3 bps (2y) with the very long end clearly outperforming (30y -4.4 bps). In Europe, equities ended virtually flat, while in the U.S. they lost some ground (Nasdaq -0.84%). The trade-weighted dollar index extended its recent bottom by rising above 103.62 (23.6% rebound from the Oct-Nov decline).
The EUR/USD lost mirror support at 1.0883. The pair quickly approached the next reference at 1.08 (38.2% retracement), but it never came to an actual test. EUR/USD closed at 1.0836. The Pound’s stellar run came to a halt at EUR/GBP resistance at 0.8558. Technical trading lifted the pair to 0.8578 at the close. Asian markets are copying Wall Street’s meager performance yesterday by losing ground. South Korea underperformed (-1.8%). News flow is focused on inflation in the country as well as the Tokyo reading in Japan (see below). The Reserve Bank of Australia kept interest rates on hold, with further hikes, if any, depending on the data.
The Aussie Dollar is underperforming global peers this morning. In Europe, we stick with the ECB‘s Schnabel interview published by Reuters this morning. The influential hawk took further rate hikes off the table in a dovish shift from a month ago. Three unexpectedly benign inflation readings in a row changed Schnabel’s mind. She noted last month’s “remarkable” drop in the core measure. Schnabel also cautioned against giving markets too much forward guidance when inflation surprises. Dropping forward guidance was appropriate when prices rose well above expectations, but it works both ways, she reasons.
As for ending PEPP reinvestments earlier than currently communicated (2025), Schnabel called it no big deal as the purchase volumes are small and markets are already anticipating it. The euro erased small gains after the headlines hit the wires, while Bund futures price action suggests a lower open for cash yields. Attention shifts to the U.S. later today with the JOLTS report as well as the ISM services report for November. Market sentiment suggests that there’s still a risk of an asymmetric reaction to a negative surprise. However, there’s little room to add to the current market pricing, which is already pricing in a 66% chance of a March cut. Any spillover from US bonds to Europe should limit the damage for the dollar against the euro, especially after Schnabel’s comments. EUR/USD 1.08 is the first target, followed by 1.0733/56.
News and Views
The Reserve Bank of Australia left its cash rate unchanged at 4.35%. The RBA raised the cash rate by 25 basis points last month after a 4-month hiatus as progress in bringing inflation back to target was slower than expected. The RBA indicated that new information received since then had been broadly in line with expectations. Monthly data pointed to a further decline in goods inflation. The path of services inflation remained uncertain.
Wage growth picked up in September, but the RBA doesn’t expect it to rise much further. Higher interest rates are working to establish a more sustainable balance between aggregate supply and demand as previous rate hikes continue to work their way through the economy. This gives the RBA time to assess the impact of the precious tightening in a data-dependent approach.
The RBA concludes that “whether further policy tightening is needed to ensure that inflation returns to target within a reasonable timeframe will depend on the data and the evolving assessment of risks”. The tone of the RBA’s assessment was perhaps a little less hawkish than the market was expecting. The 2-year yield (4.08%) fell 5 bps. AUD/USD fell from 0.6610 to 0.6585.
November inflation in South Korea and Japan came in softer than expected this morning. CPI in SK fell 0.6% M/M, slowing the y/y measure from 3.8% to 3.3% (3.5% was expected). Core inflation cooled from 3.0%. The BoK last week raised its inflation forecast for this year (3.6%) and next year (2.6%), but today indicated that it expects inflation to continue decelerating at a moderate pace, assuming oil prices don’t rise significantly.
The CPI excluding fresh food (which is monitored by the BoJ) in the Tokyo area fell from 2.7% to 2.3% in November. The measure excluding fresh food and energy slowed to 3.6% from 3.8%. The Tokyo data is seen as a good indicator for the national data to be released on December 22. The BoJ holds its last meeting of the year on December 19th. Softer inflation is likely to reinforce the BoJ’s view that it can proceed very gradually when considering policy normalization.
