The recent range is a tough ceiling to break for euro rates Even if ECB hawks continue to talk up the odds of July and September hikes, with the former still flagged as a more than even probability even by centrist members, it will take a pick-up in activity data for markets to price a terminal rate above 4%, as they did before the Silicon Valley Bank failure in March.   We’re not expecting a huge change in communication in short, and markets will focus on changes in economic data instead to infer how many more hikes the ECB has under its belt. In that context, we think longer-dated rates struggle to break above the top of their recent range, which roughly sits at 2.54% for 10Y Bund and 3.16% for 10Y swaps against 6m Euribor.   In light of the current lack of direction in financial markets, these levels may seem difficult to achieve, but the pre-ECB and Federal Reserve meeting lull is proving a fruitful time for primary market activity. On the sovereign side, Spain and France announced deals yesterday which we think will add to other deals in pushing yields up today.   Taking a step back, May has seen issuance volumes above historical averages every single week as opportunistic borrowers used this window of calm to push deals. We don't think this week will be any different. This shouldn’t be mistaken for a conviction macro trade, but we think the benign market conditions should continue to result in higher bond yields and weaker safe havens as investors feel more comfortable with owning riskier alternatives.       Big debate on direction from the US. We look for upward pressure on yields for now In the US, there is a stark juxtaposition between strong ongoing payroll growth versus PMIs and ISMs entering recessionary territory (low 40s for some components of the manufacturing PMI). On the inflation front, there is evidence of more subdued pipeline pressure while core inflation remains elevated (in the area of 5%).   Our model for US "rates" pitches fair value at 6% when we take everything into account. That has drifted up from 5.75% in the past week or so. Relative to this, the funds rate (ceilling at 5.25%) is not too deviant from that. But longer tenor rates are quite low relative to the big figure of 6%, reflecting ongoing deep inversion of the curve.   While there are some good reasons to expect market rates to fall (weak PMIs for example), our preferred expectation from here is to see some further upward pressure on market rates first. The 4% area for the 10yr Treasury yield for example remains a generic target that could well be hit in the coming month or so.     Today's events and market view Today’s session should be relatively light on economic releases with only US trade standing out. Instead, we expect the focus to be on the Bank of Canada’s meeting in the afternoon. Consensus is for no change in policy rates but the surprise Reserve Bank of Australia hike yesterday, as well as a greater skew towards a hike in the most recent contributions to the Bloomberg survey, means markets are on high alert. Bond supply will be concentrated in the 3Y sector with sales from the UK and Germany (a green bond in the latter’s case). Spain and France mandated banks for the sale of 10Y and 15Y linker bonds via syndication. ECB speakers on the last day before the pre-meeting quiet period will be VP Luis de Guindos, Klass Knot, Fabio Panetta, and Boris Vujcic.

Rates Spark: Enough out there to nudge market rates higher Weak economic data dents the European Central Bank’s ability to push rates up. Even if July and September hikes were fully priced in, Bund and swap will find it hard to rise above the top of their recent range. Direction is far from clear, but our preference is to position for upward pressure on yields.     Soft economic data dents ECB hawkish rhetoric For financial markets, a flurry of weak economic activity data – most prominently in the manufacturing sector such as yesterday’s German factory orders and tofay's industrial production – sits awkwardly with the European Central Bank's (ECB) message that more monetary tightening is needed.   The pre-meeting quiet period starts tomorrow, making today the last opportunity to skew investor expectations but markets pricing a 25bp hike at this meeting are unlikely to move much. Another important clue as to future policy moves will be in the staff forecasts released at the same time as next week’s policy decision.   The 2025 headline and core inflation projections at the March meeting stood at 2.1% and 2.2% annualised, above the ECB’s target and a clear signal that more tightening is needed – even above and beyond the path for interest rates priced by the market in late February.   Dovish-minded investors can point to a decline in oil and gas futures since the March meeting, as well as a downtick in consumer inflation expectations in the most recent survey released yesterday. Will this be enough for the ECB to no longer signal that it has ‘more ground to cover’? Probably not, but markets may not care. The focus among hawks is squarely on core inflation and the modest decline from a 5.7% peak in March to 5.3% in May hasn’t been met with much relief by the Governing Council, but it has pushed euro rates down relative to their dollar peers.        

CEE: Dovish NBP leads us to bearish view on zloty Today, another series of economic data from the CEE region continues. Industrial production data will be published in Hungary and retail sales for April in the Czech Republic. Later, the Czech National Bank will release intervention numbers for April – but it can be assumed that the central bank was not active in the market given the current EUR/CZK level. The last time the central bank intervened in the FX market was last October.     Later today, at 3pm local time, we will see a press conference from the Governor of the National Bank of Poland. As expected, rates remained unchanged yesterday and the statement didn't show anything new either. Today's press conference will be the main focus of the market and we can expect a rather dovish tone supported by lower-than-expected inflation for May.     The situation in the FX market in the region remains unclear in what direction it will take. The Polish zloty will of course be the main focus. Given the expected dovish tone of the governor, the market is likely to be open to price in more monetary easing, pushing the interest rate differential down.   However, this is not the main driver at the moment and if anything, it is more global sentiment that is deciding the zloty. At the same time, it is hard to see what role the MinFin operation in the FX market may play in the strongest levels of the zloty since June 2021. However, the strong long market positioning and dovish NBP leads us to a rather bearish view on the zloty and we see a rather higher EUR/PLN after the end of the press conference today above 4.490.

CAD: Our call is a BoC hawkish hold today The Bank of Canada moved considerably earlier than other central banks to the dovish side of the spectrum and has kept rates on hold since January. Now, stubborn inflation, an ultra-tight labour market and a more benign growth backdrop are building the case for a return to monetary tightening. Markets are attaching a 45% implied probability that a 25bp hike will be delivered today.   While admitting it’s a rather close call, we think a hawkish hold is more likely (here's our full meeting preview), as policymakers may want to err on the side of caution while assessing the lagged effect of monetary tightening. We still expect a return to 2% inflation in Canada in the early part of 2024 with the help of softer commodity prices. Developments in the US also play a rather important role for the BoC: recent jitters in the US economic outlook (ISM reports recently added to recession fears) and the proximity to a “toss-up” FOMC meeting would also warrant an extension of the pause.   Still, we expect another hold by the BoC to be accompanied by hawkish language. Markets are pricing in 40bp of tightening by the end of the summer, and we doubt policymakers have an interest in pushing back or significantly disappointing the market’s hawkish expectations given recent data. So, as long as a hold contains enough hints at potential future tightening, we think the negative impact on CAD should be short-lived and we keep favouring the loonie against other pro-cyclical currencies in the current risk environment.

EUR: European currencies still unloved The euro continues to suffer from a softening inflation story in the eurozone. Yesterday, April’s report on consumer expectations showed a considerable drop (12-month gauge down to 4.1% from 5.0% in a month), which triggered a rally in the euro area’s front-end yields. This has prevented any re-tightening in the 2-year EUR-USD swap rate gap, despite the slight decline in Fed hawkish expectations after Monday’s US ISM numbers.   While easing inflation should build a case for the doves, ECB communication has not seen drastic changes as we head into next week’s policy announcement. Yesterday, President Christine Lagarde reiterated her call for more tightening, and her hawkish tone is probably a key factor keeping markets attached to the 40-45bp pricing for the July meeting. We have other speakers to keep an eye on today. Barring major dovish remarks, and unless a BoC hike has a positive spill-over on the dollar, we feel EUR/USD can remain anchored to 1.0700 for now.   Elsewhere in Europe, pressure on Scandinavian currencies has resumed. EUR/SEK is trading at 11.684 this morning: the intra-day all-time print is at 11.79, and as we have reiterated multiple times in recent publications, the lack of any support from the Riksbank is making it hard to pick a top for the pair in the near term. The financially-distressed Swedish landlord SBB is reportedly denying rumours about discounted sales of its business units, but a default warning from creditors has emerged and the centrality of the firm in the Swedish real estate space means more risk premium (related to a property market collapse) could be priced into SEK now. A recovery for the krona seems unlikely in the near term.

FX Daily: A close call on the Bank of Canada today We expect a hawkish hold by the Bank of Canada today, but pressure on policymakers to hike has risen and it’s admittedly rather a close call. We don’t think it’s a make-or-break event for CAD – but we should keep an eye on the implications of a hike for the broader market and the dollar. In the CEE region, the main focus will be the NBP press conference.   USD: Lack of domestic factors A quiet data calendar has left the pricing for the Federal Reserve's June meeting little changed, with a 20-25% implied probability of a hike after the soft ISM services figures on Monday. That and the generally supported environment for equities haven’t triggered any substantial dollar correction though.   The market’s bearish mood on European currencies remains the prevailing theme, and the dollar’s resilience probably denotes reluctance to add dollar shorts ahead of the US CPI risk event on 13th June – which is still seen as having the potential to tilt the balance to a hike the following day.   We think markets will watch the Bank of Canada decision (which we discuss in detail in the CAD section below) with great interest today. Following the Reserve Bank of Australia rate hike yesterday, another hawkish surprise from a developed central bank in the run-up to the FOMC meeting could cause the revamp of some hawkish speculation, especially considering Canada’s economic affinity with the US.   Given the lack of other market-moving events today, a BoC hike could end up supporting the USD too. But, as discussed in our BoC preview, we expect a hawkish hold – in which case the spill-over into the dollar may not be very material given that should be insufficient to prompt markets to price out the implied chances of a Fed June hike currently embedded in the USD curve.

German industrial production remains weak in April With another rebound that was too weak to bring any substantial relief, industrial production increased by a meagre 0.3% month-on-month in April. WIthout any significant pick up in activity, the German economy's recession could continue in the second quarter.     A disappointing rebound The German economy is still licking its wounds after the disastrous March performance. Industrial production just joined the trend of exports and retail sales, which all rebounded marginally in April but failed to bring substantial relief. If the economy doesn’t gain more momentum over the coming two months, the second quarter could end up with another contraction. In April, industrial production increased by 0.3% month-on-month, from an upwardly revised -2.1% MoM in March. For the year, industrial production was up by 1.6%. Industrial production is still some 5% below its pre-pandemic level. Activity in the construction sector surprised positively, increasing by 2% MoM, while the production of automotives dropped by 0.8% MoM. Production in the energy-intensive sectors dropped by 1.1% MoM in April and was down by almost 13% over the year.     So what next? Looking ahead, the optimism at the start of the year seems to have given way to more of a sense of reality. Production expectations have weakened again to the lowest level since October last year, order books are thinning out rapidly and the inventory build-up doesn’t bode well for industrial production in the coming months. Sure, there could still be some technical rebounds, but the expected slowdown of the US economy – as well as the well-known structural factors like the ongoing war in Ukraine, demographic change and the current energy transition – will structurally weigh on the German economy in the coming years.

ECB Preview: Don’t look back in anger A 25bp rate hike looks like a done deal for next week’s European Central Bank meeting. However, with growth disappointing, the economic outlook getting gloomier and inflation dropping, arguments for several more rate hikes are becoming weaker. That said, the ECB is likely to ignore this.   Macro developments since the May meeting have clearly had more to offer the doves than the hawks at the ECB. Headline inflation has continued to come down but remains far off 2%, survey-based inflation expectations have also started to slow, growth has disappointed and confidence indicators seem to have peaked. In previous times, such a backdrop would have been enough for the ECB to consider pausing rate hikes and wait for the effects of the rate hikes so far to fully unfold. However, the ECB is fully determined right now to err on the side of higher rates.   Minutes of May meeting point to ongoing tightening bias This tightening bias was also reflected in the minutes of the ECB’s May meeting. The surprisingly weak Bank Lending Survey ahead of the last meeting clearly scared some ECB members enough to slow the pace of rate hikes but not enough to start thinking about an end to, or at least a pause in, the hiking cycle. In fact, a large number of ECB members assessed the risks to price stability as being clearly tilted to the upside over the policy-relevant horizon.   High underlying inflation and stubbornly high core inflation were the main reasons behind the ECB’s view that the conditions were not in place to “declare victory” or to be complacent about the inflation outlook.     Staff projections won't bring substantial change Next week’s meeting will also bring a new round of ECB staff projections. While gas prices have dropped further since the last projections in May, oil prices are broadly back at where they were in March. Market interest rates have also hardly changed and only the slightly weaker euro could technically add some inflationary pressure. At the same time, however, it will be interesting to see how the ECB is dealing with the disappointing soft and hard macro data of late.   Remember that back in March, the ECB expected eurozone GDP growth to return to its potential quarterly growth rate of 0.4% quarter-on-quarter from the third quarter of 2022 onwards. This was a surprising forecast given the delayed adverse impact from monetary policy tightening and ongoing structural transitions. It was also remarkable as at the same time, inflation was forecast to return to 2% by the end of 2025. An economy growing at full speed which also gradually allows inflation to disappear is a very unlikely phenomenon.     For next week, we expect slight downward revisions to the ECB’s GDP growth forecasts for this year and next but hardly any revisions to the inflation forecasts. This would mean that the ECB sticks to the 2025 forecast of 2.1% for headline and 2.2% for core inflation.     Hiking will continue, and not only next week Despite the recent decreases, actual headline and core inflation and expectations for inflation only to return to target in two years from now are clear arguments for the ECB to not only continue hiking by 25bp next week but to also keep the door open for rate hikes beyond then.   However, the eurozone economy has turned out to be less resilient than anticipated a few weeks ago and confidence indicators, with all the caveats currently attached to them, point to a weakening of growth momentum again. As headline inflation is gradually retreating, the risk increases that any additional rate hike could quickly turn out to be a policy mistake; at least in a few months from now. Still, the ECB simply cannot afford to get it wrong again.     This is why they are putting more than usual emphasis on actual inflation developments. Even if this completely contradicts forward-looking monetary policy, the ECB is in no position to take a chance and is not giving any impression that it might look back in anger.