The US currency clearly remains in pole position


Yesterday, the markets had to deal with multiple divergent news on both inflation and growth. Most of the data still suggests that the former is becoming a bigger and bigger obstacle for the latter. Chinese data warn that tough corona measures are making the second-largest economy a drag rather than a driver for global growth, as they will add to both supply chain disruptions, higher prices and demand for same time.

EC confidence fell faster than expected from 106.7 to 105. The supply/industry related sub-series were not too bad, but the European consumer is clearly worried that the war in Ukraine could trigger a prolonged crisis in the cost of living (-22.0 against -16.9).

The latest US eco data held up, but the April manufacturing ISM (55.4 vs. 57.1 vs. 57.6 expected) shows that price/supply issues are still abound, but demand is also showing tentative signs of easing. Initially, all this led to real risk aversion, especially on European indices. The EuroStoxx50 lost 1.85%. The American indices after a hesitant start finally rebounded (Dow +0.26%, Nasdaq +1.63%).

US yields did not change course despite growth uncertainty, up between 4.7/4.9 bps (5-y/10y) and 1.7 bps (2-y). The breakdown of movement in 10-year yields was striking. The US 10-year real rate jumped more than 15 basis points to 0.14%, partially offset by lower inflation expectations (-11 basis points). Two days before the Fed decision, market confidence is high that Fed rate hikes and QT will do the trick.

The German yield curve also steepened with the 2-year rate down by 1.9 bps and the 30-year rate up by 4.8 bps. There has also been a slight easing of inflation expectations in EMU. However, EMU 10-year inflation swaps have now risen above their US counterparts (3.08% vs. 3.0%), illustrating the loss of confidence in the ECB’s mandate to anchor inflation to its 2.0% target over the policy horizon, and possibly well beyond.

The DXY USD index reversed Friday’s correction (near 103.74) but failed to break through last week’s high. EUR/USD is still struggling to avoid a break below 1.05. The British Pound initially outperformed the Euro, but a late session setback even caused EUR/GBP to close north of 0.84.

This morning, the Japanese markets and the main Chinese markets are closed. Later in the day, JOLTS job openings in the US, German labor market and EMU data are interesting but not moving the market. Investors will mostly rely on tomorrow’s Fed decision unless unexpected news from the Ukraine dispute interferes. We are keeping a close eye on whether the US real yield will extend its run into positive territory. In more constructive risk sentiment, this should not immediately translate into further dollar acceleration. That said, the US currency clearly remains in pole position. At the same time, it will be difficult for EUR/USD to avoid a return to the corrective low of 1.0341 unless the ECB steps up its anti-inflationary commitment decisively.

News headlines

The Reserve Bank of Australia completed a sudden reversal of its policy at the Riksbank by raising its key rate this morning from 0.1% to 0.35%. Further rate hikes are on the way to ensure that inflation returns to target. The RBA has also decided to no longer reinvest the proceeds of maturing government bonds. The Australian economy has been resilient and inflation has picked up faster and to a higher level than expected. It also appears that wage growth is accelerating, a key factor for the RBA to begin a tightening cycle. Australian GDP growth is expected to remain strong at 4.25% this year and 2% next year. A further rise in inflation is expected in the short term (6% headline; 4% underlying), before moderating towards 3% (upper tolerance band) by mid-2024. AUD/USD (0.71) bounces away from the danger/support zone into the 0.70 low. The AUD swap curve is flattening with yields up 2.7bps (30yrs) to 13.5bps (2yrs). Australian markets are pricing in another 250 cumulative basis points of rate hikes this year.

The US manufacturing ISM disappointed yesterday, falling from 57.1 to 55.4 while the consensus expected a slight improvement to 57.6. The stock reading was the weakest since September 2020. Details showed widespread weakness, also on the demand side. Actual production fell from 54.5 to 53.6, with new orders and export orders falling to 53.5 and 52.7 respectively. Employment barely held above the neutral 50 level. Supply-side issues remain in play, with supplier shipments dropping from 65.4 to 67.2 and businesses cutting inventories. Price pressure was slightly lower than in March, but is still very high at 84.6.

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