The Morning Hark - 9 Sep 2022
Today’s focus ……A Nation in Mourning. ECB and Powell reflections and the European Emergency Energy Meeting.
All prices are at 7.50 BST with changes reflecting movement from midnight BST
A nation mourns. The UK wakes up for the first time in over 70 years without the Queen as its Head of State. A sad few days of reflection lie ahead for the country as it reflects on her reign and the stability she brought the country over many decades. May she rest in peace.
Oil - Brent and Crude November futures stabilising somewhat in Asia currently trading up smalls at 89.40 and 83.10 respectively. Oil has had a couple of quieter sessions consolidating in the lower end of its recent range after the sell off earlier in the week. Few points to note. The US took the Iran nuclear deal off the table for now. The EIA data showed a big build which was again helped by a large drain from the SPR which is now down to an almost 40 year low. On that point JP Morgan issued a report yesterday estimating that the OPEC+ could announce cuts of upto 1m bpd in oil “to steady the market”.
EQ - Equity markets happy to go with the better risk theme for now with the Nikkei, Hang Seng and the Kospi all up on the day at 27,985, 19,373 and 309 respectively.The Hang Seng having a near 3% gain on the back of fresh stimulus hopes out of Beijing.
The Nasdaq and S&P steady in the Asian session currently at 12,365 and 4013 respectively as they consolidate their gains from yesterday shrugging off higher US yields.
Near term levels for the S&P at 3970 and 4030 above.
Gold - Gold Dec futures up close to one percent overnight in Asia at 1732. Little to add here as we see 1700 support with topside remaining that noisy zone of 1750/55.
FI - US yields consolidate near their recent highs overnight with the US2y and 10y yields currently trading at 3.50% and 3.30% respectively holding onto the majority of their post ECB and Powell gains.
European yields as you’d expect rallied post ECB and got further help from a reminder from “sources” that 75bps was on the table for October closing at 1.728 and 3.952 for the German and Italian 10y yields respectively. We wouldn’t be surprised to see the spread widening again between these two as the market tests the resolve of the ECB. On the open Italian 10y yields are rallying strongly. One definitely worth watching.
FX - The USD continuing its weakness despite the rally in US yields. USD Index is currently back below 109 at 108.87. As you’d expect all the majors benefitting with USDJPY almost one percent lower at 142.74 helped by BoJ jawboning this morning. The EUR and GBP both close to a percent higher at 1.0067 and 1.16 respectively. As you’d expect with the USD on the backfoot and risk more in play the AUD and NZD both up too at 0.6836 and 0.6107 respectively. Further big miss in the Yuan fix with a 500pip+ miss but again USDCNH softer with the general USD theme at 6.9360.
The overall move given the rates move does feel more profit taken driven as the USD has come a long way fairly quickly. Its early days and it will be choppy but there does feel like a sea change of sorts with the BoJ, MoF, Brainard, Lagarde and the PBOC all mentioning the USD of late and several key levels have held with 1.14 in GBP, the EUR not liking it much below 0.99, 145 in USDJPY and 7 for the CNH. As I say early days but the profit taking we have seen today makes a lot of sense.
Others - Bitcoin and Ethereum enjoying the better risk tone and some with the pair trading at 20,700 and 1712 respectively.
So they did what they should and not what I thought.
The highlights from the meeting and statement:
The decision was seen as “front loading” the rate profile to get rates to a level that will ensure a return to target inflation. Also seen as assisting the ECB’s heavy lifting before a recession (although from their forecasts this s not their base case)
As the deposit rate now is above zero the two tier is suspended temporarily by setting the multiplier to zero but no reverse tiering system was announced (more below)
Rates are expected to rise further based on incoming data
Asset purchases will continue
Growth forecasts 2022 3.1% (prev 2.8%), 2023 0.9% (2.1%) and 2024 1.3% (2.1%)
Inflation forecasts 2022 8.1% (prev 6.8%), 2023 5.5% (3.5%) and 2024 2.3% (2.1%)
Soundbites from the Lagarde press conference:
Downside risks to growth projections
Upside risks to inflation projections
Rate hike magnitude was a unanimous decision
75bp is not the new normal
Noted EUR depreciation
Don’t know where terminal rate is
Will hike in at least 2 more but no more than 5 meetings
If and when the TPI criteria is met the ECB stands to act
As ever the ambiguity from the ECB never fails to amaze. They hike 75bps but say it’s front loading. They want to appear hawkish but suspend the two tier. They lower growth but say there will be no recession and they tighten with one hand but continue QE with the other.
The technicians in the market were focused on the temporary suspension of the two tier system for reserve requirements and how this will play out. During 2020/21 over the pandemic the European banks borrowed large quantities of EURs from the ECB via the TLTRO (Targeted longer term refinancing operation. I post below the ECB web page) at negative interest rates. Voluntary repayments could be made next year and as such with rates going up this is something the banks may have considered and if they had this would have started to shrink the ECB’s balance sheet. However the suspension of the two tier system meant that there was no incentive to pay back these loans early as banks will make more money retaining these loans and in addition to no new news on QT there will be no shrinking of the ECB balance sheet any time soon, excess liquidity shall remain in the system and the pain trade is kicked down the road.
Forecasters had expected the ECB to raise the borrowing costs, at some point, to incentivise the banks to repay the loans but this seems a mid 2023 trade at best now.
In effect the ECB has kept excess liquidity in the markets and is willing to pay billions into the EU banking system for longer. This is a long term negative for the EUR and potentially was brokered in an attempt to support the banking system through the energy crisis. Only time will tell but at some point people are going to have to stand on their own two feet.
Initial market reaction was muted at best with a barely 20bp rally in EUR and 5bp in the German 10y yields. Why so? The ECB were hawkish, signalled more to come and delivered what the market was looking for. Buy the rumour, sell the fact could have played a part in it to an extent. Also the ambiguity we mention above didn’t help sentiment and the suspension of the two tier system once the implications became apparent definitely weighed on the EUR. Later in the day “leaked ECB sources” stressed that a 75bp hike in October was on the table if inflation data warrants it. That got the EUR and European rates moving in the direction the ECB obviously wanted to close the day eventually higher.
The forecasts also stood out to us with the ECB anticipating merely one quarter of negative growth (q4 22) and hence no recession thank you very much. Seems a tad optimistic to us and surely revisions will be incoming.
Onto today’s European emergency energy meeting and its proposals which will have potentially huge implications for inflation and growth in the Eurozone. Everything would appear be on the table from recent European soundbites; price caps, rationing, windfall taxes and even nationalisation. Let’s see.
Not much to really excite the markets. He welcomed the increase in labour market participation and once again was strong in his belief that the Fed’s job was far from done in combatting inflation; “need to act now, forthrightly, strongly as we have been doing and we have to keep at it until the job is done”.
I guess the forum did not give him much scope to be specific on the near term and the speech appeared to be more structural in nature.
Other Fed speakers rolled out much the same chatter of late.
Barkin claimed that 4%ish Fed Funds was “plausible”
Evans sees rates around 3.25/50% by year end and at 4% early next year. Also 75bps was a possibility for September. However he did caution that increasing rates too quickly might take data dependency off the table.
Treasury Secretary Yellen flagged the inflation print next week opining that the gas price drop to reflect in the next CPI print.
Market now firmly in the 75bp camp for September, almost full priced, with the terminal rate now a shade under 4% by q1 next year.
One further point of interest in the US a WSJ piece is starting to gather much attention (I post it at the bottom). It is released from the Brookings Paper on Economic Activity and it argues four main points on the US fight with inflation. Inflation expectations need to be kept under control, accept 5% unemployment if inflation remains still high, more attention is needed on the ratio of job openings to unemployment and median inflation as the Fed assesses the tightness of the labour market and underlying inflation and most interestingly that target inflation should be raised to 3%. This reflects some of Powell’s recent talk surrounding the structural shifts in inflation and whether they are temporary or here to stay. Indeed it’s something we’ve mentioned of late “what is target now”. Let’s see but it feels like this theme is going to evolve more over the next few months.
The Day Ahead
European emergency energy meeting will be the markets focus and any soundbites from there will be keenly jumped upon. Elsewhere we get the Canadian employment report and Fed speakers later in the day where we expect more of the same.
Canada Unemployment Rate Aug consensus 4.9% vs previous 5% (13.30 BST)
Canada Employment Change Aug consensus 15k vs previous -30.6k (13.30 BST)
Canada Average Hourly Wages YoY Aug previous 5.4% (13.30 BST)
Canada Capacity Utilisation q2 previous 82% (13.30 BST)
Eurozone Emergency Energy Meeting
Evans (15.00 BST)
Waller and George (17.00 BST)
Good luck and a good weekend to one and all.
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I am sad that Queen Elizabeth II passed away for many reasons and will miss her face on the rear or their Britannica, Canadian Maple, and Aussie Kangaroo coins. I'll try buy some more before they're all new King Charles III coins.