Financial Conditions

Key events in developed markets and EMEA next week

There's growing evidence that tight monetary policy and restrictive credit conditions are having the desired effect on depressing inflation. However, neither the Federal Reserve nor Bank of England will want to endorse the recent ramping up of rate cut expectations in financial markets as both prepare to release decisions next week.

 

US: Pushback from the Fed

The Federal Reserve is widely expected to leave the Fed funds target range at 5.25-5.5% at next week’s FOMC meeting. Softer activity numbers, cooling labour data and benign inflation prints signal that monetary policy is probably restrictive enough to bring inflation sustainably down to 2% in coming months, a narrative that is being more vocally supported by key Federal Reserve officials. The bigger story is likely to be contained in the individual Fed member forecasts – how far will they look to back the market perceptions that major rate cuts are on their way? We stro

FX Daily: Eurozone Inflation Impact on ECB Expectations and USD

Financial Conditions Look Quite Scary. How Central Banks Fight Inflation?

ING Economics ING Economics 04.09.2022 11:00
Market rates are set to rise as financial conditions are not tight enough in the US; the US 10yr yield could even go as far as topping 3.5% again. That will pull rates higher elsewhere, including those in the eurozone. Remarkably, financial conditions are significantly tighter in the eurozone than in the US. That heaps more pressure on the Fed than on the ECB In this article So, how do central banks fight inflation exactly? Eurozone financial conditions are already looking quite scary Remarkably, US financial conditions are still too loose A stark contrast So, how do central banks fight inflation exactly? Central banks impact the macroeconomy by finessing financial conditions. It’s not as simple as setting official rates though; it requires the wider financial system to push in the same direction. Most importantly, market rates need to be in tune with central bank thinking. Credit spreads are key too; wider credit spreads add to the all-in funding costs for corporates and households, amplifying the impact of higher market rates. And this together with other central bank liquidity management tools will broadly determine overall financial conditions. Not sure I'd recognise a financial condition if I saw one ...   Source: ING estimates Eurozone financial conditions are already looking quite scary In the eurozone, the Bloomberg measure of financial conditions has seen a virtual collapse from June through to August. At the beginning of June, conditions were moderately tight (about 0.25 of a standard deviation below normal). By the end of August, they were extremely tight (some 2.5 standard deviations below normal). This contrasts with extremely loose conditions at the beginning of 2022 (1.5 standard deviations above normal). The ECB of course hiked in mid-July, preceded by an end to bond buying (and targeted longer-term refinancing operation unwinds), which tightened eurozone financial conditions. Remarkably, lower market rates and tighter credit spreads through July did not prevent an overall tightening in eurozone financial market conditions. In fact, they're looking quite scary right now. They are practically back to the extreme briefly seen when the pandemic first struck, and the only periods where eurozone financial conditions were tighter were during the Great Financial Crisis of 2008 and the Sovereign Debt Crisis of 2011. This suggests that the ECB has less to do. All they need to do is sustain this, not intensify it. Super big hikes are not needed. Remarkably, US financial conditions are still too loose There is a remarkable contrast to be drawn with the US, where financial conditions tightened right through to the end of June (1.5 standard deviations below normal), driven by Fed hikes, rising market rates and wider credit spreads. But then it reversed. A notable fall in market rates and a tightening in credit spreads, which ran from mid-June to end-July, loosened US financial conditions quite considerably, pulling them practically back to almost normal by mid-August. Remember the US 10yr yield fell from 3.5% to almost 2.5% during this period, and risk assets rallied. Hence the easing in conditions. This easing was counter-productive to the Fed’s stated ambition to tighten financial conditions, and was a factor underpinning the crystal clear speech from Chair Powell at Jackson Hole: this Fed wants and needs to see tighter financial conditions, and will do its bit to tighten them by hiking the funds' rate at upcoming Federal Open Market Committee meetings. In fact, in the lead-up, and through the second half of August, market rates and credit spreads reverted and started to do what they should be doing at this stage of the cycle, rising and widening respectively. A stark contrast Currently, we find a stark contrast between the eurozone and the US. US financial conditions are just 0.35 of a standard deviation below normal, while eurozone ones are 2.5 standard deviations below normal; even though it’s the Fed that’s done most of the tightening. From the perspective of the US, a required objective is to re-tighten conditions considerably from here, which is code for rising bond yields and widening in credit spreads, to be capped off with a 75 basis point hike from the Fed on 21 September. For the eurozone, things are more opaque. There is a deeper energy-impacted macro crisis afoot, and financial conditions are already super tight. Higher market rates and wider credit spreads ahead can deepen this further. The ECB can cap this off with a decent hike in September but does not need to do as much cajoling as the Fed might have to do in the weeks ahead. And the ECB does not need to do as much aggregate hiking either, relative to the job the Fed still has to do.     Source: https://think.ing.com/articles/rates-for-monthly-heres-why-rates-will-keep-rising/?utm_campaign=September-01_rates-for-monthly-heres-why-rates-will-keep-rising&utm_medium=email&utm_source=emailing_article&M_BT=1124162492   Disclaimer This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more
Debt Ceiling Drama! How the Bond Market Reacts and What It Means for Rates

Debt Ceiling Drama! How the Bond Market Reacts and What It Means for Rates

ING Economics ING Economics 30.05.2023 08:38
Rates Spark: Debt ceiling deal adds to bond angst A deal to raise the US debt ceiling increases selling pressure on Treasuries, but will also result in tighter financial conditions for the economy. This opens upside to EUR rates but a soggy economic backdrop means wider rate differentials near-term.   Once approved, the debt limit deal paves the way to a liquid crunch  The deal between President Biden and House leader McCarthy amounts to the removal of a tail risk for financial markets, that of a US default. Even if this was a tiny probability event to begin with, it'll allow markets to focus on the more important debate: whether the Fed is indeed done with its hiking cycle. The budget deal, which lifts the debt limit for two years and caps some categories of government spending, still needs to be approved by the House tomorrow.   The outcome of the vote is uncertain but the likely opposition by some Republicans means Democrat votes will be key. We expect the run-up to the vote to see Treasury Yields gradually climb higher if more lawmakers come out in favour of the deal.   Money markets can expect a $500bn liquidity drain over the coming months Beyond tomorrow, US rates will quickly look past the deal and turn their attention to the Treasury's task of rebuilding its cash buffer at the Fed. Two aspects matter here. On the liquidity front, money markets can expect a $500bn drain over the coming months as more debt is issued. In a context of $95bn/month Quantitative Tightening (QT) and of likely tightening of at least some banks' funding conditions, this should amount to an additional drag on financial conditions for the broader economy.   This should ultimately draw a line under the US Treasury selloff but, should the new borrowing come with an increase in maturity, some of that support may be weakened.   The case for a June hike has strengthened after Friday's higher than expected core PCE print and Treasuries are set to trade softly into Friday's jobs report as recent prints have demonstrated the labour market's resilience. 4% yield for 10Y now seems a more achievable level.   Weak European data prevents EUR rates from rising as fast as their US peers        
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The Dilemma for the Federal Reserve: To Hike or Hold This Week?

Michael Hewson Michael Hewson 13.06.2023 15:46
To hike or to hold for the Fed this week     When the Federal Reserve last met at the beginning of May raising rates by 25bps as expected, the market reaction was relatively benign. There was little in the way of surprises with a change in the statement seeing the removal of the line that signalled more rate hikes were coming, in a welcome sign that the US central bank was close to calling a halt on rate hikes.     Despite this signalling of a possible pause, US 2-year yields are higher now than they were at the time of the last meeting.     This is primarily due to markets repricing the likelihood of rate cuts well into next year due to resilience in the labour market as well as core inflation. Some of the recent briefings from various Fed officials do suggest that a divergence of views is forming on how to move next, with a slight bias towards signalling a pause tomorrow and looking to July for the next rate hike.      At the time this didn't appear to be too problematic for the central bank given how far ahead the Federal Reserve is when it comes to its rate hiking cycle. The jobs market still looks strong, and wages are now trending above headline CPI meaning that there may be some on the FOMC who are more concerned at the message a holding of rates might send, especially given that the RBA and Bank of Canada both unexpectedly hiked rates this past few days.     With both Fed chair Jay Powell leaning towards a pause, and potential deputy Chair Philip Jefferson entertaining similar thoughts in comments made just before the blackout period, the Fed has made itself a hostage to expectations, with the ECB set to raise rates later this week, and the Bank of England set to hike next week, after today's big jump in wage growth.       This presents the Fed with a problem given that it will be very much the outlier if it holds tomorrow. Nonetheless there does appear to be increasing evidence that a pause is exactly what we will get, with the problem being in what sort of message that sends to markets, especially if markets take away the message that the Fed is done.     If the message you want to send is that another hike will come in July, why wait when the only extra data of note between now and then is another CPI and payrolls report. You then must consider the possibility that these reports might well come in weaker, undermining the commitment to July and undermining the narrative for a further hike that you say is coming, thus loosening financial conditions in the process.     While headline inflation may well be close to falling below 4% the outlook for core prices remains sticky, and at 5% on a quarterly basis, and this will be an additional challenge for the US central bank, when it updates its economic projections, and dot plots.   The Fed currently expects unemployment to rise to a median target of 4.5% by the end of this year. Is that even remotely credible now given we are currently at 3.7%, while its core PCE inflation target is 3.6%, and median GDP is at 0.4%.     As markets look to parse this week's new projections the key question will be this, is the US economy likely to be in a significantly different place between now and then, and if it isn't then surely, it's better to hike now rather than procrastinate for another 5 weeks, especially if you are, as often claimed "data dependant".       By Michael Hewson (Chief Market Analyst at CMC Markets UK)  
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Fed Signals Rate Pause as UK GDP Aims for April Rebound

Michael Hewson Michael Hewson 14.06.2023 08:30
Fed set for a rate pause; UK GDP set to rebound in April    European markets closed higher for the second day in a row, after the latest US inflation numbers for May came in at a 2-year low, and speculation about further Chinese stimulus measures boosted sentiment.   US markets followed suit although the enthusiasm and gains were tempered ahead of today's Fed meeting as caution set in ahead of the rate announcement.   Having seen US CPI for May come in at a two year low of 4%, in numbers released yesterday, market expectations are for the US central bank to take a pause today with a view to looking at a hike in July. Of course, this will be predicated on how the economic data plays out over the next 6-7 weeks but nonetheless the idea that you would commit to a hike in July begs the question why not hike now and keep your options open regarding July, ensuring that financial conditions don't loosen too much.   Today's May PPI numbers are only likely to reinforce this more dovish tilt, if as expected we see further evidence of slowing prices, with core prices set to fall below 3% for the first time in over 3 years. Headline PPI is expected to slow to 1.5%, down from 2.3%.       When Fed officials set out the "skip" mindset in their numerous briefings since the May decision when the decision was taken to remove the line that signalled more rate hikes were coming, there was always a risk that this sort of pre-commitment might turn out to be problematic.   So, while markets are fully expecting the Fed to announce no change today, Powell's biggest challenge will be in keeping the prospect of a July rate hike a credible outcome, while at the same time as outlining the Fed's economic projections for the rest of the year, as well as for 2024.   In their previous projections they expect unemployment to rise to a median target of 4.5% by the end of this year. Is that even remotely credible now given we are currently at 3.7%, while its core PCE inflation target is 3.6%, and median GDP is at 0.4%.     Before we get to the Fed meeting the focus shifts back to the UK economy after yesterday's unexpectedly solid April jobs data, as well as the sharp surge in wages growth, which prompted UK 2-year gilt yields to surge to their highest levels since 2008, up almost 25bps on the day.   While unemployment slipped back to 3.8% as more people returned to the work force, wage growth also rose sharply to 7.2%, showing once again the resilience of the UK labour market, and once again underlining the policy failures of the Bank of England in looking to contain an inflation genie that has got away from them.   This failure now has markets pricing in the prospect that we could see bank rate as high as 6% in the coming months, from its current 4.5%. The risk is now the Bank of England, stung by the fierce and deserved criticism coming its way, will now overreact at a time when inflation could well start to come down sharply in the second half of this year.   So far this year the UK economy has held up reasonably well, defying the doomsters that were predicting a 2-year recession at the end of last year. As things stand, we aren't there yet, unlike Germany and the EU who are both in technical recessions.   Sharp falls in energy prices have helped in this regard, and economic activity has held up well, with PMI activity showing a lot of resilience, however the biggest test is set to come given that most mortgage holders have been on fixed rates these past two years which are about to roll off.     As we look to today's UK April GDP numbers, we've just come off a March contraction of -0.3% which acted as a drag on Q1's 0.1% expansion. The reason for the poor performance in March was due to various public sector strike action from healthcare and transport, which weighed heavily on the services sector which saw a contraction of -0.5%.     The performance would have been worse but for a significant rebound in construction and manufacturing activity which saw strong rebounds of 0.7%.     This isn't expected to be repeated in today's April numbers, however there was still widespread strike action which is likely to have impacted on public services output.   The strong performance from manufacturing is also unlikely to be repeated with some modest declines, however services should rebound to the tune of 0.3%, although the poor March number is likely to drag the rolling 3M/3M reading down from 0.1% to -0.1%.       EUR/USD – failed at the main resistance at the 1.0820/30 area, which needs to break to kick on higher towards 1.0920. We still have support back at the recent lows at 1.0635.     GBP/USD – finding resistance at trend line resistance from the 2021 highs currently at 1.2630. This, along with the May highs at 1.2680 is a key barrier for a move towards the 1.3000 area. We have support at 1.2450.      EUR/GBP – has slipped back from the 0.8615 area yesterday, however while above the 0.8540 10-month lows, the key day reversal scenario just about remains intact. A break below 0.8530 targets a move towards 0. 8350.     USD/JPY – looks set to retest the recent highs at 140.95, with the potential to move up towards 142.50.  Upside remains intact while above 138.30.      FTSE100 is expected to open 10 points lower at 7,585     DAX is expected to open 15 points lower at 16,215     CAC40 is expected to open 3 points lower at 7,288
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Fed's Rate Hike Guessing Game: Managing Market Expectations. Inflation Concerns and Tightening Credit Conditions: Fed's Decision and Market Reaction

Ipek Ozkardeskaya Ipek Ozkardeskaya 15.06.2023 08:52
The Federal Reserve (Fed) refrained from raising interest rates at this week's monetary policy meeting. Yet the median forecast on the Fed's dot plot suggested that there could be two more rate hikes before the end of this year. That came as a slap on the face of those expecting a rate cut by the end of the year, even though, I think that the doves haven't said their last word just yet. The credit conditions in the US are tightening, inflation is falling. Yesterday's PPI data revealed a faster than expected contraction in producer prices in May, while both headline and core CPI figures continued to ease over the same month.    Why, on earth, has the Fed started playing a guessing game, instead of hiking the rates right away?   It is because the US policymakers know that the idea of a 25bp hike - or two 25bp hikes - is more powerful than a 25bp hike itself, as future rate hikes are more effective in managing market expectations. The market is keen to go back to pricing the end of rate hikes - and rate cuts - when they know that the Fed is coming toward the end of the tightening cycle. To avoid that end-of-tunnel enthusiasm from jeopardizing tightening efforts, the Fed keeps the tightening suspense alive, without however acting on the rates. If all goes well - if inflation continues easing, and tighter financial conditions begin weighing on US jobs market - the Fed will have the option to step back and simply... not hike.  But for now, 'nearly all policymakers' remain concerned with the moderate cooling in core inflation, and they don't see inflation going below 3% this year.       Mild reaction  The US 2-year yield continues pushing higher, while enthusiasm at the long end of the yield curve is lesser, as higher rates increase recession odds. The S&P500 hit a fresh high since last year but closed almost flat. The US dollar rebounded off its 100-DMA, and the EURUSD rallied above its own 100-DMA and holds ground above the 1.08 mark this morning, into the widely watched European Central Bank (ECB) decision.    A hawkish ECB hike?  The ECB is broadly expected to hike the interest rates by 25bp when it meets today, and ECB chief Lagarde will likely sound hawkish at the press conference following the decision and insist that despite the recent easing in inflationary pressures – and perhaps the deteriorating economic outlook, the ECB will continue its efforts to fight.  Note that 500-billion-euro TLTROS will mature on June 28th and will pull a good amount of liquidity out of the market. While there is still around 4 trillion euros of excess liquidity in the financial system, the draining liquidity could cause anxiety among investors, especially if some European banks fail to find enough financing in the market to replace their TLTRO funding – a scenario which could sap investors' confidence and appetite in the coming weeks.     In this respect, Italian banks are under a close watch as they are behind their European pears in repaying their TLTRO and the funding through TLTROs are more than the excess cash its lenders parked with the ECB. That means that Italian banks must find money somewhere else – but where? – to repay their TLTROs.   I am not particularly worried about the stability of the European financial system, but I can hardly imagine European stocks extend rally in the environment of draining liquidity and rising rates. The Stoxx 600 index spiked above its 50-DMA yesterday, as a stronger euro may have reinforced appetite, yet European stocks will likely return to the 435-450 area.       China cuts.  In China, we have a completely different ambiance when it comes to inflation and monetary policy. The Chinese inflation remains flat and under pressure near 26-month lows, growth is not picking up the anticipated post-Covid momentum, and the People's Bank of China (PBoC) cut its one-year MLF rate by 10bp today, as broadly expected, to give a shake to the depressed Chinese economy. The problem is, there is now a talk that China could be entering a liquidity trap, meaning a period where lower rates fail to boost appetite and don't translate into faster growth.  
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Navigating the Monetary Policy Dilemma: Markets, Central Banks, and Financial Conditions

ING Economics ING Economics 27.06.2023 10:48
The monetary policy dilemma when markets won't listen The second, related, point is that it is debatable how much central banks can really tighten monetary policy on their won in a data-dependent regime. There has clearly been a reappraisal of global central banks’ reaction functions in June, but the result has been much flatter yield curves. To the extent that this is a symptom of higher short-end rates and unchanged long-end rates, this is a net tightening of financial conditions, an albeit a disappointingly limited one. The problem arises when, even as short-end nominal rates rise, long-end real rates drop. Taking EUR 5Y5Y real rates as an example, they have dropped 40bp since their peak a month ago, hardly a tightening of financial conditions.   What’s more, risk assets have taken the recent change of central bank tone in their stride, see for instance the spectacular tightening of sovereign spreads. The ECB may well gush that its policy stance is well transmitted, tighter sovereign and credit spreads suggest the cost of funding remains affordable for the economy. This is good news, but also suggests that a more hawkish stance is needed to yield results, but with increasing downsides. This is the choice faced by central bankers at this week’s Sintra conference: chase the diminishing returns of a hawkish stance, or accept that a lot of the financial variables responsible for ultimately supressing inflation are beyond their control.     Risk assets have taken the more hawkish central bank tone in their stride   Today's events and market view The data calendar this morning is dominated by Italian sentiment indicators, followed in the afternoon by US durable goods orders, house prices, new home sales, conference board consumer confidence, and the Richmond Fed manufacturing index. The ECB’s Sintra conference is underway with interventions scheduled by President Lagarde, and Dhingra and Tenreyro from the Bank of England. More curve flattening is on the cards if central banks continue to push the hawkish envelope, at the expense of a slowing economy. This may take the form of a bear-flattening, however, given the recent fall in rates. The weekly ECB MRO allotment will be in focus as the facility might be used by some banks to finance the repayment of TLTRO loans. Bonds supply will come from the Netherlands (30Y), Italy (3Y/7Y), and the UK (10Y Linker). The German federal state will publish its third quarter funding update.
Spanish Elections and Economic Policy: Uncertainty and Growth Outlook

Spanish Elections and Economic Policy: Uncertainty and Growth Outlook

ING Economics ING Economics 12.07.2023 14:14
The outcome of the Spanish elections could lead to changes in economic policy. However, the reactivation of European fiscal rules in 2024 limits the extent to which fiscal policy can be adjusted, limiting the risk to our growth outlook.   Uncertainty surrounding Spanish elections Following major losses in the recent regional and local elections on 28 May, Prime Minister Pedro Sanchez of the Socialist Workers' Party (PSOE) has called for early elections in Spain. Although the latest polls indicate a shift to the right side of the political spectrum, the outcome of the upcoming elections remains uncertain. If the polls are correct, the conservative People's Party (Partido Popular) will get the most votes, but not the majority to form a government. In such a scenario, the third-largest party, the far-right Vox, will play a decisive role in forming a government. As elections approach in Spain, the political landscape is characterised by high fragmentation and polarisation. Over the past decade, the Spanish political landscape has undergone a significant transformation, with a remarkable increase in the number of parties. This fragmentation has led to greater instability as coalition governments must now be formed, which often rely on a fragile consensus. Based on the latest polls, it seems likely that another coalition government will have to be formed.     How the Spanish election could affect the economic outlook Spain's economy has outperformed that of other eurozone countries over the past year, but is still weighed down by structural weaknesses such as high debt, low productivity and a rigid labour market. Despite a historically low unemployment rate, it is still among the highest in the eurozone and youth unemployment is alarmingly high. Moreover, the country has still not fully recovered from the pandemic, despite last year's impressive growth figures. The elections could also be the starting point of a longer period of political instability, although this is not our baseline scenario. This could happen if the election results make it difficult to form a stable majority, leading to protracted government negotiations. In addition, there is still a real possibility that a clear majority cannot be formed, which would lead to a hung parliament necessitating new elections and prolonging political uncertainty. In such a scenario, crucial structural reforms needed for the economy may be delayed, reinforcing existing weaknesses. Persistent uncertainty about future government policies could also undermine investor confidence and hamper investment activities. If a new right-wing government comes to power, it could bring about a change of course in economic policy. Conservative leader Feijóo has already announced plans for more business-friendly policies and tax cuts, including a proposed income tax cut for people earning less than €40,000 a year. There is also a real chance that the planned closure of nuclear power plants in 2027 will be postponed to secure energy supplies. The extent of these policy shifts will depend on the consensus among coalition partners and the strength of their majority. If the right-wing Conservatives and Vox form a comfortable majority, they will feel more supported to reverse certain previous government policies. Despite a possible change of direction in economic policy, there is little room to shift to a more stimulative fiscal policy. Spain's public debt ratio is one of the highest in the eurozone at 113.2%. Spain ranks below Greece (171.3%), Italy (144.4%) and Portugal (113.9%). According to current forecasts, Spain will overtake Portugal in the ranking this year. This shift is due to a lower expected government deficit in Portugal combined with slightly better growth prospects. Spain recorded a deficit of 4.8% of GDP in 2022, and both our forecast and that of the Bank of Spain suggest that the deficit will remain above the 3% threshold at least until 2025. This level is considered an excessive deficit by the European Commission. The reactivation of European fiscal rules in 2024 will increase pressure on fiscal consolidation measures. Regardless of the election outcome, addressing public finances will be inevitable, further limiting the government's flexibility to pursue more expansionary fiscal policies.   Government debt to GDP ratio, 2022   New government will take office amid a slowing economy Spain's economy was the fastest-growing of all larger eurozone countries in the first quarter, growing 0.6% quarter-on-quarter. Like other southern countries, Spain benefited from growth in net exports driven by a continued rebound in tourism. In addition, the Spanish economy benefited from some structural differences, such as a relatively smaller industrial sector compared to, for instance, Germany. It is precisely this energy-intensive industry that has suffered the most from higher energy prices and tightening financial conditions. Finally, Spanish energy prices, partly due to the introduction of the gas price cap, have not risen as much as in several other countries. Despite the good start, maintaining this positive momentum may be challenging. Although several factors such as a pick-up in wages, improvements in global supply chains, falling energy prices, and government support packages are giving some tailwind, the tightening of financial conditions will increasingly cast a shadow on the economy. It is hard to imagine that the rapid and significant increase in policy interest rates will not significantly slow economic growth. The external environment is also expected to weaken further, with the eurozone experiencing a technical recession over the past two quarters, China's economic recovery falling short of expectations and US growth expected to slow. This could also affect Spain's tourism sector. A slowdown in the global economy could lead to less international travel, limiting the growth of the tourism sector in 2024.   Spain recorded the strongest growth among larger euro countries in the first quarter      
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Tapping into Tourism: Spain's Growth Driven by the Tourism Sector

ING Economics ING Economics 12.07.2023 14:16
Tourism will be the main growth driver this year The slowdown in the Spanish economy can be attributed to the overall deceleration of the global economy. Nevertheless, Spain is poised to become the best-performing economy among the larger eurozone countries this year. We forecast average growth of 2.2% for Spain this year, well above the eurozone average of 0.4%. Continued growth in the tourism sector will be the main driver of Spain's higher growth rates. Although the number of international tourists entering Spain in 2022 was still 14% below pre-pandemic levels, the gap may be closing this year. In May, the number of international visitors had already risen to 104% of the pre-pandemic level, compared with 88% in May 2022. Strong travel demand points to a promising tourist season ahead. Contributing about 15% to GDP, the tourism sector will remain one of the main catalysts for economic growth throughout the year.   The number of foreign tourists increased above pre-Covid levels in April and May (in millions)     Spanish headline inflation reaches 1.9% Spanish inflation has fallen faster than in other eurozone countries. In June, Spanish inflation stood at 1.9% year-on-year, while the eurozone recorded 5.5%. These positive developments can be attributed to more favourable base effects from energy prices, which rose faster in Spain than in other countries last year. However, if these favourable base effects fade in the coming months, Spanish headline inflation could rise again. In addition, the phasing out of several government measures by early 2024 is expected to have an upward effect on inflation. Spanish core inflation, excluding energy and food prices, remains remarkably high at 5.9% and is even above the eurozone average of 5.4%. Core inflation is expected to remain at a high level throughout the year and gradually decline. Yet there are indications that core inflation is also on a sustained downward trend. For instance, inflation in the buoyant hospitality sector, which accounts for 14% of the inflation basket, is cooling markedly despite strong sustained demand on the back of a strong tourist season. Core inflation is expected to remain at high levels throughout the year and only gradually decline.   Slowing momentum despite tourism recovery For 2023, we expect growth of 2.2%, well above the eurozone average of 0.4%. Although the economy performed strongly in the first quarter, momentum is expected to wane as financial conditions tighten. The main driver of growth will be net exports, supported by the continued recovery of the tourism sector, which surpassed pre-pandemic levels in May and April. Although headline inflation fell to 1.9% in June, it is expected to rise in the coming months due to less favourable base effects for energy and persistent core inflation.   Spanish economy in a nutshell (%YoY)  
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Spanish Inflation: A Closer Look at Headline and Core Rates

ING Economics ING Economics 13.07.2023 09:23
Spanish headline inflation reaches 1.9% Spanish inflation has fallen faster than in other eurozone countries. In June, Spanish inflation stood at 1.9% year-on-year, while the eurozone recorded 5.5%. These positive developments can be attributed to more favourable base effects from energy prices, which rose faster in Spain than in other countries last year. However, if these favourable base effects fade in the coming months, Spanish headline inflation could rise again. In addition, the phasing out of several government measures by early 2024 is expected to have an upward effect on inflation. Spanish core inflation, excluding energy and food prices, remains remarkably high at 5.9% and is even above the eurozone average of 5.4%. Core inflation is expected to remain at a high level throughout the year and gradually decline. Yet there are indications that core inflation is also on a sustained downward trend. For instance, inflation in the buoyant hospitality sector, which accounts for 14% of the inflation basket, is cooling markedly despite strong sustained demand on the back of a strong tourist season. Core inflation is expected to remain at high levels throughout the year and only gradually decline.   Slowing momentum despite tourism recovery For 2023, we expect growth of 2.2%, well above the eurozone average of 0.4%. Although the economy performed strongly in the first quarter, momentum is expected to wane as financial conditions tighten. The main driver of growth will be net exports, supported by the continued recovery of the tourism sector, which surpassed pre-pandemic levels in May and April. Although headline inflation fell to 1.9% in June, it is expected to rise in the coming months due to less favourable base effects for energy and persistent core inflation.   The Spanish economy in a nutshell (% YoY)
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Mixed Sentiment as China's Q2 Growth Disappoints; US Earnings Take Center Stage

Michael Hewson Michael Hewson 17.07.2023 08:45
China growth disappoints. US earnings in focus The Chinese economy grew 6.3% in Q2 and that's faster than a 4.5% growth in Q1 but lower than the market estimate of 7.3%. Now don't be blindsided by the strong look of these numbers, because the latest figures were distorted by a low base effect last year when Shanghai and other big cities were in lockdown and life in China was running at a very low speed. If we look at a seasonally adjusted basis, the Chinese economy grew by only 0.8%, slowing sharply from a 2.2% rise in Q1.   Market sentiment regarding the weakening growth numbers is mixed. In one hand, weak growth means that the government and the People's Bank of China (PBoC) will step up efforts to further ease the financial conditions and pave the way for a quicker recovery. On the other hand, supportive policies put in place so far have had little impact. The Chinese property downturn, risk of disinflation, and falling exports have been difficult to reverse. As a result, the kneejerk reaction in markets was unenthusiastic. American crude extended retreat below the $75pb, after hitting and bouncing lower from the 200-DMA, that stands near $77pb last week. The rejection was expected, and the selloff could deepen toward the 100-DMA, near $73.50 level. Copper futures are also down this morning and testing the 100-DMA following a 7% rebound since the start of the month. Iron ore futures remain under pressure, and the Aussie is down nearly 1.30% against the US dollar, after forming a double top near the 69 cents level last week, on the back of a broad-based dollar weakness.   Zooming out, the US dollar is not further sold across the board this Monday, but the dollar index consolidates near the lowest levels since April 2022, and is below the 100 mark and is expected to further cool down. The softer dollar is good for cooling inflation elsewhere than the US, it could be good for boosting the revenues of US companies, including the Big Tech, which suffered from a rapid appreciation of the greenback last year, and it's good for boosting the US exports – which should support the US economic growth.   So, all eyes are now turning toward the US companies' earnings this week. The first earnings from the bis US banks came in better-than-expected last Friday and added to the overall investor enthusiasm after the US inflation data confirmed an encouraging easing in the US inflation, which in return softened the hawkish Federal Reserve (Fed) expectations and fueled a rally in both stock and bond markets.   JPMorgan Chase, Citigroup, and Wells Fargo all reported stronger-than-expected earnings last quarter due to rising interest rates. Deposits in Citigroup were nearly flat, Welss Fargo for saw its deposits fall 1% compared to Q1, and 7% compared to a year ago, and the average interest rates that the banks had to pay on deposits to prevent them from evaporating and going toward higher-yielding investments, rose 1-3% and their interest expenses climbed significantly. But still, JP Morgan's net interest income rose 44%, Citi's 16% and Wells Fargo's nearly 30%! Some smaller banks like Silicon Valley Bank, Signature Bank, and First Republic struggled with the effects of higher interest rates, as well. And deposit levels at major banks have been declining, with growth turning negative and reaching -6%, its lowest level in April. Blackrock amassed some good inflows and closed the quarter just shy of $10 trillion under management. The mix of the good and the bad led Citigroup shares 4% down. Wells Fargo first rallied before closing the day in the negative on Friday. The upcoming earnings reports from Bank of America, Morgan Stanley, and Goldman Sachs will be closely watched, among other big names.  On the list of companies that are due to release earnings this week, we find Netflix, Tesla, IBM, TSM, American Airlines and American Express. Overall, analysts project that S&P 500 companies will see the biggest contraction in earnings growth during the second quarter, where profits are expected to fall by 7-9% year-over-year. That doesn't really match what we see in the S&P500 chart, as the index advanced to a fresh high since April 2022 and is up by around 24% since last October dip. But the reality is that, with just over 5% of companies in the index having reported, profit growth for the period is on track to have contracted by 9.3% thus far, according to Bloomberg. It's too early to call of course because the tech is what carried the S&P500 this high over the past half-a-year and their earnings should be the ones to confirm the nice rally we saw on index level, but we could come down to earth with less shinier figures on that end. Yes, AI boosts revenue, and revenue expectations but Taiwan's exports of chips fell for the 6th consecutive month in June due to weaker global demand. Exports decreased more than 20% from a year earlier to a four-month low and when  you think that the island is home to some big and loved names like Apple and Nvidia's go-to chipmaker, TSMC, you question whether the biggest annual decline in Taiwan's chip exports since March 2009 isn't a warning that equity investors may have gone ahead of themselves when rushing to these stocks.     By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank  
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Fed to Keep up the Squeeze with Another 25bp Hike

ING Economics ING Economics 24.07.2023 09:48
Fed to keep up the squeeze with another 25bp hike The Federal Reserve is set to resume its policy tightening on 26 July. Inflation is moderating but remains well above target and with a tight jobs market and resilient activity, officials may feel they can't take any chances. The Fed will continue to signal the prospect of further hikes, but with the credit cycle turning, we doubt it will carry through.       25bp hike an obvious call After 10 consecutive interest rate hikes over the previous 15 months, the Federal Reserve left the Fed funds target rate unchanged at 5-5.25% in June. While it was a unanimous decision, there was hawkish messaging in the accompanying press conference and updated Fed forecasts, signalling a broad consensus behind the idea of two more rate rises later in the year. Fed Chair Jerome Powell stated that the long and varied lags in monetary policy meant that the decision should be interpreted as a slowing in the pace of rate hikes rather than an actual pause. While inflation is moderating, it is still far too high and with the jobs market remaining very tight, the Fed can’t take any chances. The commentary since then remains consistent with this messaging, with broad support among officials that the 26 July Federal Open Market Committee (FOMC) announcement will be for another 25bp rate rise, taking the Fed funds range to 5.25-5.5%. Fed funds futures contracts are pricing 24bp with economists nearly universally expecting a 25bp hike   Keeping the door open for additional tightening The scenario graphic outlines the options open to the Fed and our sense of the likely market consequences of those actions. The no change and 50bp hike options seem very remote possibilities given comments from officials. The dilemma is whether the Fed hikes 25bp and sticks with the view that it needs to signal the likely need for one or more rate hikes or whether it moves more to a data dependency stance. A data dependency narrative would be a shift in position and lead the market to latch onto the possibility of the Fed not hiking further. This would likely see Treasury yields and the dollar fall quite significantly, which would loosen financial conditions in the economy. Given low unemployment, robust wage growth and the fact that core inflation is still running at more than double the 2% target, this is not something Fed officials would willfully countenance. Consequently, we put a 70% probability on the 25bp hike scenario that includes commentary emphasising the need to be attentive to inflation risks, that growth needs to slow below trend and that further rate hikes “may be appropriate”. We would then say there is a 25% chance of a more dovish 25bp hike, signalling a likely peak for rates, while the 0bp and 50bp outcomes each have a 2.5% chance of materialising.   Tighter lending standards suggest credit growth will turn negative
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Rates Spark: Fed Set to Keep Pressure on Amid Consumers' Confidence and Upward Yield Trend

ING Economics ING Economics 26.07.2023 08:30
Rates Spark: The Fed set to keep the pressure on A key driver of market rates of late has not been the projection for the July FOMC meeting, but rather the projection for where the Fed gets to at the end of the rate cutting cycle to come. The market has been busy pricing out future rate cuts as a reflection of residual macro robustness. That's helping to elevate long dated rates, and we expect that to continue.   Consumers show confidence and yields head higher In the US, a lot of the macro oomph that was seen through much of the June data is continuing to show up in the July readings. A case in point was yesterday's consumer confidence number. It had been slipping through to May, and looked at that point that it could easily lurch lower. But from around 102 (vs a reference of 100), it popped up to 110 for June, and then to 117 for July. That's now running at 17% above average, which is remarkable for an economy that is being (apparently) battered by higher interest rates, high inflation and a weak international backdrop.   These types of data keep the pressure on the Federal Reserve to maintain a hawkish tilt to policy. Yes, the manufacturing PMI and other survey evidence points to a recessionary tendency in the US ahead. But at the same time such warning flags have been flying for over a year now, and here we are with the consumer seemingly getting more optimistic. We doubt very much that this lasts, as the headwinds of tighter financial conditions should ultimately bite harder than currently being seen. Similarly, the tightening in financial conditions seen in Europe is having a significant dampening effect on the takedown of credit, as the latest ECB survey shows.   That said, we continue to identify net upward pressure on market rates in the immediate few weeks ahead. We note that the Jan 2025 fed funds implied rate is only just under 4%. This was closer to 3% when Silicon Valley Bank went down. That paved a route, at the time, for the 10yr Treasury yield to trend in the same direction – towards 3%. But not, that route is being obstructed by a markedly lower rate cut discount for the Federal Reserve through 2024 and into 2025. For that reason, and despite the macro headwinds ahead, we continue to remain positive for the US 10yr Treasury yield to head back up to a 4% handle.   Auctions have been heavy as interest has been drying up in Treasuries Yesterday's 5yr auction in the US tailed, meaning that the yield at auction was higher than the market yield at the point of issue. And this was at a point where market yields were on the rise. Typically tailed auctions happen when yields are falling, or when there is underwhelming demand. The latter was applicable to yesterday's auction. The bond was well covered and had a reasonable indirect bid (often representing players like central banks). But it just was not that firm in terms of overall tone. The 2yr auction on the previous day was also well covered, but it took the highest yield since 2007 at auction to get the paper away. Flows in previous week had been high on long duration and quite impressive. But flows in the past week or two have been less impressive. If this continues, market yields will likely continue their drift higher. We have a 7yr auction today. The good thing is its not in as rich a spot of the curve as the 5yr is. But it's still below the 2yr yield, and requires a bit of an appetite for duration.   Today's events and market views The big event today is the Federal Open Market Committee outcome, from which a 25bp hike looks to be virtually guaranteed (as a zero or 50bp hike is quite unlikely). A 25bp hike is 97% priced in, so that is what the Federal Reserve is likely to deliver. The question is what Chair Powell will say, and ahead of that, the tone from the FOMC statement. In all probability that tone and Chair Powell's phraseology will be hawkish. He has little to gain from showing even a smidgen of reduced hawkishness. The Fed will feel they need to keep the pressure on, and especially during a period that has been as risk-on as we've seen of late. In the eurozone we have to wait till Thursday for the European Central Bank decision (should be a 25bp hike), while no change is expected from the Bank of Japan at this juncture. More on that tomorrow.
FX Daily: Lagarde and Powell Address Jackson Hole – Hawkish Expectations and Eurozone Concerns

FX Daily: Lagarde and Powell Address Jackson Hole – Hawkish Expectations and Eurozone Concerns

ING Economics ING Economics 25.08.2023 09:27
FX Daily: Lagarde faces a harder test than Powell The world’s two most prominent central bankers are both speaking at Jackson Hole today. The dollar has strengthened into the risk event and we think a hawkish tone by Powell is now largely priced in. Lagarde has to deal with a worsening economic outlook in the eurozone, but we suspect she will stick to data dependency and a hawkish tone. EUR/USD can rebound.   USD: Powell hawkishness looks largely in the price Some Fed speakers laid the groundwork for today’s keynote speech by Fed Chair Jerome Powell at the Jackson Hole Symposium. This bulk of Fedspeak comes after a rather quiet summer in central bank communication. A couple of standouts from yesterday’s remarks: Patrick Harker (2023 voter) leaned on the dovish side and said that the Fed has “probably done enough” on policy tightening. Susan Collins (non-voter) also suggested the Fed may have to hold for some time but refrained from signalling where the peak is. We also heard from former Saint Louis Fed President James Bullard, who stuck to his usual hawkish rhetoric. Bullard’s successor is still to be named, but the St. Louis seat is not going to be voted for until 2025, so the impact shouldn’t be imminent. So, what’s on the agenda for Powell today? Arguably, the backdrop has not changed dramatically since the FOMC rate announcement a month ago. The disinflation process has progressed in line with expectations, while key activity indicators have continued to prove resilient. Surely, the rather substantial revision in payrolls suggests a less rosy picture for employment than originally indicated, but we doubt that could be enough to trigger a change in the overall policy communication. Powell will once again have to deal with his own Committee’s projections that see rates being raised one last time this year: he will probably reiterate the Fed is open to such a possibility and retains a data-dependent approach. Markets will hardly be surprised by that, or by any restatement that rate cuts are still a long way out. The recent rise in US rates is surely complementing the monetary-policy-induced tightening of financial conditions, but given the stabilisation in the bond market following the July-August big sell-offs, we don’t think Powell will be overly concerned about prompting fresh UST weakness. The recent firmness in the dollar probably factors in some of the markets’ expectations for a hawkish tone by Powell, so we don’t expect another USD rally today. Christine Lagarde’s speech may have a greater impact on the euro (as discussed below) and cause a DXY correction.
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Dream JOLTS Data Sparks Optimism and Market Gains

Ipek Ozkardeskaya Ipek Ozkardeskaya 30.08.2023 09:43
Dream JOLTS data By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank     Yesterday was a typical 'bad news is good news' day. Risk sentiment in the US and across the globe was boosted by an unexpected dip in US job openings to below 9 mio jobs in July, the lowest levels since more than two years, and an unexpected fall in consumer confidence in August. The weak data pushed the Federal Reserve (Fed) hawks to the sidelines, and bolstered the expectation of a pause in September, and tilted the probabilities in favour of a no hike in November, as well. $    Note that the latest JOLTS data printed the ideal picture for the Fed: Job vacancies eased, but hiring was moderate and the layoffs remained near historically low levels. The data also suggested that the era of Great Resignation, where quit rates hit a record, could be over, as people quitting their jobs retreated to levels last seen before the pandemic. The US 2-year yield dived 15bp, the 10-year yield fell 8bp, while the S&P500 jumped nearly 1.50% to above its 50-DMA and closed the session at a spitting distance from the 4500 level. 90% of the S&P stocks gained yesterday; even the Big Pharma which had a first glance at which medicines will be subject to price negotiations with Medicare held their ground. But of course, tech stocks led the rally, with Nasdaq 100 closing the session with more than a 2% jump. Tesla was one of the biggest gainers of the session with a more than a 7.5% jump yesterday.    US and European futures suggest a bullish open amid the US optimism and news of upcoming deposit and mortgage rate cuts from Chinese banks.    On the data front, all eyes are on the US ADP report and the latest GDP update. The ADP report is expected to reveal below 200K new private job additions in August, while the US growth is expected to be revised from 2% to 2.4% for the Q2 with core PCE prices seen down from 4.90% to 3.80%. If the data is in line with expectations, we shall see yesterday's optimism continue throughout today. Again, what we want is to see – in the order of importance: 1. Slowing price pressure, 2. Looser, but still healthy jobs market, 3. Slowing but not contracting economy to ensure a soft landing. We will see if that's feasible.     In Europe, however, that slow landing seems harder to achieve. Today, investors will keep an eye on the latest inflation updates from euro-area countries, and business and sentiment surveys. We expect to see some further red flags regarding the health of the European economy due to tighter financial conditions in Europe and the energy crisis. German Chamber of Commerce and Industry warned yesterday that German businesses are cutting investments and move production abroad due to high energy prices at home. The EURUSD flirted with 1.09 yesterday, as investors trimmed their long dollar positions after the weak JOLTS data. The AUDUSD rebounded, even though the latest CPI print showed that inflation in Australia slowed below 5% in July, a 17-month low. In the UK, shop prices fell to a 10-month low. But it won't be enough for central bankers to cry victory just yet, because the positive pressure in energy prices remains a major concern for the months ahead. The barrel of American crude is pushing toward the $82pn level, with improved trend and momentum dynamics hinting that the bullish development could further extend.  
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Rates Spark: Close calls as EUR rates drift higher ahead of ECB Decision and US Market Return

ING Economics ING Economics 05.09.2023 11:38
Rates Spark: Close calls EUR rates have drifted higher, contemplating the chances of further ECB tightening. Returning US markets today could extend the momentum of the late Friday sell-off while busy issuance could add to the upward pressure. Eventually data decides for how long 10Y UST yields can be supported in the 4 to 4.25% area, with eyes this week on tomorrow's ISM services.   With the US out for Labor Day, EUR rates drifted higher at the start of the week with the usually more policy-sensitive belly of the curve in the lead. European rates' main focus remains the ECB, given the proximity of the next meeting and given that it's the final chance officials have to communicate their policy preferences ahead of the quiet period. ECB President Lagarde’s speech yesterday yielded little concrete information regarding the ECB's  next steps –  even though the speech centred around the importance of communication. She did remark that “action speaks louder than words”. While she was arguably talking more about what the ECB has already achieved, hiking rates by 425bp over a relatively short time span of 12 months, the comment surely resonates with the ECB’s hawks' current thinking about the upcoming decision. Over the weekend the ECB’s Wunsch already opined that "a bit more" tightening was necessary. Bundesbank’s Nagel delved into more technical matters around the ECB’s decision to end the remuneration of banks' minimum reserves. He argued that more should be done on reserves – if via not rates, it seems some hawks are ready to consider other options for tightening financial conditions. Important inputs to the upcoming decision are measures of expected inflation. Market based measures, such as the 5y5y forward inflation swap, have recently come off their peaks but remain mired in relatively elevated territory. The aforementioned 5y5y forward is still close to 2.6%. As ECB's Schnabel noted in last week's speech this is also a reflection of growing uncertainty surrounding the longer inflation outlook and could in turn reflect slowly eroding credibility of the ECB’s commitment to get inflation to 2%. Today the ECB will release its consumer survey which has seen 3y median inflation expectations already drop from 3% at their peak to 2.3% as of June. That is also ready close to 2%, but before the turmoil of 2022 median expectations were usually even closer to 2%. The June survey results also pointed to a more pronounced tail in the distribution, towards higher inflation outcomes.   The last ECB hike had little traction further out the curve
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Central Banks at a Crossroads: Balancing Inflation and Financial Stability

Saxo Bank Saxo Bank 12.09.2023 11:24
 Central banks are realising that over a year of aggressive monetary policies might not have been enough to fight inflation. Financial conditions remain loose, governments continue t implement expansionary fiscal policies, and the economy is not decelerating at the expected pace. There is more tightening to do, which will continue to drive yield curves to a deeper inversion in the third quarter of the year. However, additional interest rate hikes might not work as intended. That's why policymakers must consider the active disinvestment of central banks' balance sheets to lift yields in the long part of the yield curve. As the hiking cycle approaches its end, the corporate and sovereign bond markets will provide enticing opportunities in the front part of the yield curve.   Central banks face a troubling dilemma: should they burst the bubble created by more than a decade of Quantitative Easing (QE), or are they able to fight inflation without doing that? Hiking interest rates by 500bps in the United States and 400bps in Europe has not done the job as central bankers hoped. The job market remains solid, and inflation is stubbornly sticky and well above central banks’ 2% target. All developed central banks have done so far is to drive yield curves to inversion. While an inverted yield curve puts cash-strapped companies at risk, bigger corporates continue to take advantage of lower yields in the long part of the yield curve. Amazon can raise debt at 4.5% and invest at more than 5% in short-term bills. It doesn’t take much to understand that such a rate environment would create the wrong incentives. The dream that fighting inflation won’t mean putting financial stability at risk is adding to the existing bubble. Overall, financial conditions remain loose. The Chicago Fed adjusted national financial conditions index is negative, indicating that financial conditions are looser on average than would be typically suggested by current economic conditions. Similarly, the real Fed Fund rate has turned positive at the end of March for the first time since November 2019, reaching a restrictive posture only one year and 500bps rate hikes later. The ECB, on the other hand, is markedly behind the curve with the real ECB deposit rate in the bottom range it was trading in before Covid, when the ECB was trying to stimulate growth. Yet, governments continue to perpetrate lavish fiscal policies to win the electorate, adding pressure to the dangerous inflationary environment.     The way forward: active quantitative tightening becomes preferrable over rate hikes Despite being officially ended, quantitative easing and big central banks’ balance sheets remain the core issue to sticky inflation.  The joint balance sheet of the Federal Reserve and the ECB is above $15 trillion. Currently, both central banks are not actively selling their balance sheets as they have chosen not to reinvest part of their maturing securities. Calling such a strategy “Quantitative Tightening” is just a way for them to talk hawkish and act dovish. They know that to fight the inflation boogeyman, long term yields need to rise, and the way to do that is to actively disinvest their balance sheets, which are composed of long-term bonds. The outcome might be the opposite if central banks choose to hike rates beyond expectations. The higher the benchmark rate, the more likely long-term sovereign yields will begin to drop, as markets forecast a deep recession. Such a move would work against the central banks’ tightening agenda. Thus, it’s safe to expect that the tightening cycle will come to an end in the second half of the year as more interest rate hikes than those expected by markets would just further invert yield curves rather than have a significant impact on inflation. As the tightening cycle approaches its end, we expect Federal Reserve and ECB officials to begin to talk about balance sheet disinvestments. At that point, yield curves will begin to steepen, driven by the rise of long-term yields. The front part of the yield curve might start to descend, as markets anticipate the beginning of a rate-cutting cycle. However, if interest rate cut expectations are pushed further in the future, there is a chance that they will remain underpinned for a period. Yet, this path is less certain, as it depends on the ability of policy makers to keep rate cut expectations at bay and the capability of the economy to endure periods of higher volatility. It is at this point that we expect the market to rotate from risky assets to risk-free assets, bursting the bubble created by decades of QE. We expect the first central bank to end the rate hiking cycle to be the Federal Reserve, while the ECB will need to hike a few additional times to bring the real ECB deposit rate further up. The Bank of England might need to hike into the new year, diverging further from its pee
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Global FX Markets React to Rising US Bond Yields and Dollar Strength: Navigating the Impact on Carry Trade Strategies and Emerging Market Currencies

ING Economics ING Economics 09.10.2023 16:04
Whoever is driving the sell-off in US Treasuries – be it 'bond vigilantes' protesting against fiscal policy or just a market view for structurally higher policy rates – the outcome is a dollar-positive tightening in financial conditions. Higher volatility warns of a further unwind in carry trade strategies. Undervalued currencies can stay undervalued. The rising tide of global bond yields – especially US bond yields – is becoming the dominant theme in global FX markets. Whether it is views of structurally higher policy rates or ‘bond vigilantes’ demanding governments take fiscal responsibility more seriously, the net result is tighter financial conditions. This is normally a dollar positive. Concerns over the ‘erosion of governance’ of the US budget trajectory look unlikely to be soothed any time soon. Additionally, it looks as though the Fed may keep its hawkish bias for a little longer. This means that despite November and December typically being weak months for the dollar, the dollar may in fact hold recent gains into year-end. As always, the dollar is the currency of the United States and everyone else’s problem. Here we expect Chinese and Japanese officials to keep battling to support their currencies at 7.30/$ and 150/$ respectively. EUR/USD does not look particularly undervalued and in addition to weak eurozone growth, we are concerned that the re-introduction of the Stability and Growth Pact next year could keep the euro soft.  The ING view remains that three quarters of US contraction and a 200bp Fed easing cycle will take its toll on the dollar – hence our bearish 12-month forecasts.   In terms of the broader environment, tighter financial conditions have driven volatility levels higher and sparked an unwind of the FX carry trade. That may well continue this month and is a negative for most EM currencies. Additionally contentious elections in Poland and Argentina this month could add to volatility in the EMFX complex.
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Immobile Fed: Anticipating a Pause with a Nod to Higher Yields

ING Economics ING Economics 02.11.2023 12:28
FX Daily: Immobile Fed to give a nod to higher yields We expect the Fed to pause today, in line with expectations. There is a mild risk of a dollar correction, but that should be short-lived. Japanese authorities are stepping up efforts to contain unwanted volatility in rates and FX, but we suspect markets will keep pushing USD/JPY higher and into the new intervention level.   USD: A quiet Fed meeting The Federal Reserve is in a desirable position as it prepares to announce policy this evening thanks to the combined effect of rate hikes and higher Treasury yields keeping pressure on prices. The economy has proven resilient so far. In the art of central banking, inaction is action, and inaction is broadly what we expect from the Fed today as we discuss in our preview. A pause is widely expected by markets and economists, as numerous FOMC members signalled higher Treasury yields were adding enough extra tightening of financial conditions to stay put. One question for today is to what extent the statement and Fed Chair Jerome Powell will acknowledge this non-monetary tightening of financial conditions. It’s unlikely the Fed wants to drop any dovish hints at this stage, but a market that is well positioned for a broadly unchanged policy message could be rather sensitive to the wording on this topic and may interpret an “official” recognition of tighter financial conditions as an implicit signal more tightening is off the table. The typically cautious Powell may anyway try to mitigate any dovish interpretation of the statement during the press conference. After all, the Fed dot plot still says one more hike by year-end and has a strong commitment to higher rates for longer. The first of these two statements was never taken at face value, but the latter is what is contributing to higher yields. Expect no divergence from it. The Fed isn’t the only event in the US calendar today, and markets will likely move on the ADP payrolls release (although these are unreliable), JOLTS jobs openings and the ISM manufacturing figures for October. There is room for a short-lived dollar correction today as markets will be on the hunt for implicit admissions that another hike is actually off the table with higher yields. Positioning adjustments have favoured some dollar slips recently but they have not lasted, as the overall message by the Fed has been one of higher for longer with a hawkish bias. That message won’t change today (barring any great surprises) and we think that buying the dips in any dollar correction will remain a popular trade, especially given the more and more unstable ground on which other major currencies (JPY, EUR) are standing.
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Federal Reserve Holds Rates with Hawkish Tone: Navigating Peaks, Pitfalls, and Dollar Dynamics

ING Economics ING Economics 02.11.2023 12:36
US Federal Reserve keeps its options open with another hawkish hold The Fed funds rate target range was held at 5.25-5.5% by a unanimous vote, with a hawkish tone retained to ensure financial conditions remain tight and aid in the battle to constrain inflation. Higher household and corporate borrowing costs are starting to bite though and we don’t expect any further hikes this cycle.   Rates held with a hawkish bias retained No surprises from the Federal Reserve today with the Fed funds target range held at 5.25-5.50% for the second consecutive meeting – the longest period of no change since before the tightening cycle started in early 2022. The accompanying statement acknowledges the “strong” economic activity – a slight upgrade on the “solid” description in September while there was explicit mention of “tighter financial and credit conditions”, which will weigh on the economy. Nonetheless, in the press conference Chair Powell recognises that the economy is starting to see the effects of tighter monetary policy, but that the committee still has a bias towards more hikes rather than seeing the prospect of cuts on the horizon. This is understandable since the Fed does not want to give the market the excuse to significantly backtrack on the recent repricing of “higher for longer” policy interest rates. While there does appear to be a slight softening in the degree of hawkishness the Federal Open Market Committee (FOMC) is expressing, they are careful not to provide a signal that policy has peaked, which could tempt traders to drive market rates lower in anticipation that the next move would be rate cuts. Such action could potentially reignite inflation pressures, but we doubt it.   Peak rates with cuts on the horizon for 2024 The surprise surge in longer-dated Treasury yields and the tightening of financial conditions it’s prompted will inevitably create more headwinds for activity in an environment where mortgage and car loan rates are already above 8% and credit card interest rates are at all-time highs. With Treasury yields staying at elevated levels, the need for further policy rate hikes is dramatically reduced and we do not expect any further Fed rate hikes. Consumer spending remains the most important growth engine in the economy, and with real household disposable income flat-lining, savings being exhausted and consumer credit being repaid – and this is before the recent tightening of lending and financial conditions is fully felt – means we see the primary risk being recession. If right, this will depress inflation pressures even more rapidly than the Fed is anticipating, giving it the scope to cut policy rates in the first half of next year.   Bond yields falling into the Fed meeting more to do with less (relative) supply pressure on the long end The bond market went into the FOMC meeting in a decent mood. The refunding announcement was deemed tolerable, partly as the headline requirement of US$112bn was US$2bn lower than the market had expected. Note, however, that 10yr issuance increases by US$5bn (to US$40bn) and 30yr issuance increases by US$4bn (to US$24bn), while 3yr issuance increases by just US$2bn (to US$48bn). As a stand-alone that is negative for the long end. But it’s the new December projections that has the market excited, as both 10yr and 30yr issuance is projected to fall by US$3bn (to US$37bn and US$21bn, respectively). In contrast, 2yr, 3yr and 5yr issuance volumes are to increase by US$8bn. So the issuance pressure morphs more towards shorter maturities and away from longer maturities as we head through the fourth quarter. Yields are down. The 10yr now at just under 4.8%. It has not materially broken any trends though. The big bond market story from the FOMC outcome is an underlying continuation theme. Higher real rates have been a feature since the last FOMC meeting, and the one before. And the Fed knows that this has a clear tightening effect. It’s a rise in market rates that cannot be easily diversified away by liability managers that need to re-finance in the coming few quarters. The Fed knows that both floating rate debt and all types of re-financings will amplify pain as we progress forward. Given that, it can let the debt markets do the last of the pain infliction for them. The rise in real yields has helped to push the curve steeper, and the 5/10yr has now joined the 10/30yr with a positive upward sloping curve. Only the 2/5yr spread remains inverted. This overall look does suggest the bond market is positioning for a turn in market rates ahead. The big move will come when the 2yr starts to anticipate cuts. We are not there quite yet; hence the 2/5yr inversion hold-out. That all being said, there is enough from the Fed today for the market to use the opportunity to test lower in yields. We still think we need to see the payrolls report first. If that is close to consensus then there is likely not enough to make the break materially lower. It is true that Powell has pointed to higher long rates as a pressure point. But does not have to mean that upward pressure on long rates suddenly goes away. There is still a path back up to 5% if the market decides not to use the double positive today of lower long-end supply (in relative terms) and a Fed that is pointing at long yields as something to get concerned by. We still feel that pressure for higher real rates remains a feature, despite the easing off on longer tenor issuance pressure. We need to see the economy really lurch lower, in particular on the labour market, before the bond bulls take over. The Fed is not quite pointing towards this just yet either.   FX: Too little to reverse the dollar momentum Markets perceived today’s Fed announcement and press conference as moderately dovish, and the drop in Treasury yields would – in theory – point to a softer dollar. The 2-year EUR-USD swap rate differential is around 8bp tighter than pre-meeting, but remains considerably wide at -128bp. As shown in the chart below, such a differential is consistent with EUR/USD trading around 1.05-1.06 and, despite the acknowledgement that financial conditions have tightened, there weren’t enough dovish elements to trigger a material dollar correction.   EUR/USD and 2Y swap rate gap     Looking ahead, we remain of the view that the dollar’s direction will be set by US data as the Fed’s reiteration of its higher for longer approach and threat of another hike still keep the big bulk of the bullish dollar narrative alive. Barring a negative turn in US activity data, our 1.06 EUR/USD year-end target remains appropriate. There are probably more downside risks in the month of November, although in December the dollar has negative seasonality.
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The Jobs Dilemma: Deciphering Long-End Rates Amidst Fed's Balancing Act

ING Economics ING Economics 03.11.2023 14:38
Rates Spark: US jobs data can be key It has been a big move lower in long-end rates over the past days, and today's US jobs data will be key in determining whether it has further to run. Notably, however, the front end has started to turn higher again. The Fed, having tied itself to long-end rates to a degree, may start pushing back against easing financial conditions.   The rally in long-end rates extended with curve flattening accelerating Overall, we have now seen a drop of close to 30bp in 10Y and longer yields over just two sessions – the 10Y is now at 4.66% and 30Y at 4.80%. As seen in the move higher before, it was also in large part a move in the real interest rate component in this leg lower. The 2s10s curve has reflattened by a substantial 18bp with the larger part of that dynamic actually coming yesterday. The lower-than-feared long-end supply fuelled by the US Treasury has helped, as has weaker macro data. And certainly, there was evidence of value hunters out there getting in at 'high' yield levels. Markets will now be taking a close look at today’s US jobs data to determine whether yields have further room to fall. Yesterday’s US labour market indicators have already helped provide 10Y yields the final nudge below 4.7%. The initial jobless claims ticked a little higher to 217k from 212k and more importantly continuing claims rose to 1815k. That latter figure has been rising over the past month and a half. While the rate of layoffs might still be considered low, it suggests that if you do lose your job it is becoming more difficult to find a new one.   The Fed may push back agains financial conditions easing again The rally on long-end rates over the past sessions also highlights another conundrum for the Fed. By essentially referencing the higher longer rates as reason to withhold further tightening it has created an awkward interdependency with the market. The Fed said it needed to see persistence in the changes to broader financial conditions for it to have implications for the policy path. While there are good reasons to assume that further tightening is off the table, the prospect of a larger rally in rates bringing them back again potentially limits the downside at the onset. The caveat is that this may only work to the degree that long-end rates are actually driven by policy expectations. Front-end rates certainly are and pushed actually higher yesterday with the 2Y yield close to 5% again. That in mind, the Fed’s interdependency with the market is adding to the re-flattening dynamic of the curve.   As the-long end rally extended, front-end resistence accelerated the flattening   Today's events and market view We have doubts that this is the end of rises in long-dated market rates. For that to happen we would need to see material labour market weakness, putting today's job market report squarely in the spotlight. The consensus is looking for a 180k rise in non-farm payrolls, with forecasts ranging from 125k to 235k. It will be a slowdown from September’s bumper figure of 336k, but even the consensus figure would still be relatively robust – cooling, but making it hard to argue that the labour market is really troubled yet. As for supply as a driver, the market is effectively still facing higher issuance at upcoming Treasury auctions, and we are not even speaking of unresolved long-term debt trajectory concerns. As for the weaker ISM manufacturing that had helped drive the rally, it had been in contractionary territory since last October. The more relevant indicator should be today’s non-manufacturing ISM. And with regards to the Fed, the speaker schedule is looking busier again after the meeting and the drop in longer rates may get some pushback.
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FX Markets in Flux: Navigating Fed Commentary and Global Economic Signals

ING Economics ING Economics 07.11.2023 15:51
FX Daily: Waiting for the Fed pushback FX markets are consolidating after a few risk-on days. We have seen some strange price action on the back of the RBA's 25bp hike and some mixed Chinese data. For today, it looks like a relatively quiet session, although the focus will be on how aggressively the line-up of Fed speakers wants to push back against the recent weakening of US financial conditions.   USD: Fed speakers will be in focus today FX markets have handed back a little more of their risk-on gains overnight, leaving the dollar marginally stronger. However, US ten-year Treasury yields are still down at 4.65% and last night's release of the Fed's Senior Loan Officers Survey serves as a reminder that credit conditions are tightening and lending growth is weakening – both of which are likely to weigh on the US economy over coming quarters. In quiet overnight developments, what stands out is the strange reaction in AUD/USD to the Reserve Bank of Australia's 25bp hike. The poor performance of AUD/USD may owe to positioning, or perhaps some read that if the RBA needs to restart its tightening cycle after a four-month pause, maybe the Fed does too. Yet, US rates have not moved much, and the Australian dollar also failed to gain ground on slightly better-than-expected Chinese import data. Perhaps the read here is that the market needs a lot more evidence before pushing on with the Fed pause/peak and weaker dollar scenario. Today, the US highlight will be Federal Reserve speakers, which run from 1:30 pm CET for most of the day. At issue will be whether the Fed chooses to push back against the loosening of US financial conditions. Recall that the tightening of financial conditions in mid-October prompted remarks such as the 'term premium is doing the tightening'. Now that these financial conditions have fully reversed that October spike, the Fed will presumably want to re-emphasise the risk of further rate hikes.  Risks look skewed to a mildly stronger dollar today. DXY closing above 105.50 undoes some of last week's bearish work. But from where we stand, it looks like DXY might bounce around in a broad 104.50-106.50 range into year-end.
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US Dollar Rises as Bond Market Ignites: A Look at Dollar's Resurgence

ING Economics ING Economics 10.11.2023 10:03
FX Daily: Bond bears give new energy to the dollar A very soft 30-year Treasury auction and hawkish comments by Powell triggered a rebound in US yields and the dollar yesterday. Dynamics in the rates market will remain key while awaiting market-moving US data. In the UK, growth numbers in line with expectations, while in Norway, inflation surprised to the upside. USD: Auction and Powell trigger dollar rebound The dollar chased the spike in US yields yesterday following a big tailing in the 30-year Treasury auction and hawkish comments by Fed Chair Jerome Powell. Speaking at the IMF conference, Powell warned against reading too much into the softer inflation figures and cautioned that the inflation battle remains long, with another hike still possible. If we look at the Fed Funds future curve, it is clear that markets remain highly doubtful another hike will be delivered at all, but Powell’s remarks probably represent the culmination of a pushback against the recent dovish repricing. Remember that in last week’s FOMC announcement, the admission that financial conditions had tightened came with the caveat that the impact on the economy and inflation would have depended on how long rates would have been kept elevated. The hawkish rhetoric pushed by Powell suggests that the Fed still prefers higher Treasury yields doing the tightening rather than hiking again, and that is exactly what markets are interpreting. The soft auction for long-dated Treasuries also signals the post-NFP correction in rates may well have been overdone and could set a new floor for yields unless data point to a worsening US outlook. Today’s highlights in the US calendar are the University of Michigan surveys. Particular focus will be on the 1-year inflation gauge, which is expected to fall from 4.2% to 4.0%. On the Fed side, we’ll hear from Lorie Logan, Raphael Bostic and Mary Daly. Dynamics across the US yield curve will have a big say in whether the dollar can hold on to its new gains. Anyway, we had called for a recovery in DXY to 106.00 as the Fed would have likely pushed back against the dovish repricing. The rebound in yields should put a floor under the dollar, but we suspect some reassurances from the data side will be needed for another big jump in the greenback.
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Tightening Financial Conditions and Weakening Prices: US Inflation on Track for 2% Next Summer

ING Economics ING Economics 10.11.2023 10:39
US could soon see 2% inflation After encouraging inflation data in early summer, progress stalled in August and September amid robust consumer activity. But with tighter financial and credit conditions set to weigh further on corporate pricing power, supplemented by slowing rents and falling gasoline and used car prices, we expect to see inflation move close to 2% in 2Q.   Progress being made, but the Fed wants much more At the recent FOMC press conference, Federal Reserve Chair Jerome Powell said that the economy has “been able to achieve pretty significant progress on inflation without seeing the kind of increase in unemployment that has been very typical of rate hiking cycles like this one”. Nonetheless, there was the acknowledgement that “the process of getting inflation sustainably down to 2% has a long way to go”. Headline US consumer price inflation has indeed fallen sharply from a peak of 9.1% year-on-year in June 2022, hitting a low of 3% in June 2023. However, this stalled in August and September with the annual rate rebounding to 3.7% as higher energy costs and resilience in some of the core (ex-food and energy) components re-emerged amid a strong summer for consumer spending. The annual rate of core inflation has continued to soften from a peak of 6.6% in September 2022 to 4.1% currently, but it is still running at more than double the 2% target. In an environment where the economy has just posted 4.9% annualised GDP growth in the third quarter and unemployment is only 3.9%, there are several hawks on the FOMC who continue to make the case for additional interest rate rises, arguing that they cannot take chances and allow any opportunity for inflation pressures to reignite.   Contributions to US annual consumer price inflation (YoY%)   But the Fed's work is most probably done The Fed is still officially forecasting one further 25bp interest rate rise this year, but we doubt it will follow through. The Fed last hiked rates in July and since then financial and credit conditions have tightened, with residential mortgages and car loans now having 8%+ interest rates while credit card borrowing costs are at all-time highs and corporate lending rates are moving higher. It isn’t just the rise in borrowing costs that will act as a brake on economic activity and constrain inflation pressures. The Federal Reserve’s Senior Loan Officer Opinion survey shows that banks are increasingly reluctant to lend. This combination of sharply higher borrowing costs and reduced credit availability tends to be toxic for growth. The Fed itself has reported significant weakness in loan demand while commercial bank lending data shows a clear topping out in the amount of borrowing conducted by households and businesses. With real household disposable incomes falling for the past four months amid evidence of increasing numbers of households having exhausted pandemic-era savings, we expect to see GDP contract in at least two quarters in 2024. In this environment, we see the slowdown in inflation regaining momentum in early 2024.   Corporate pricing power is waning With business attitudes becoming more cautious on the economic outlook we are seeing a reduction in price intention surveys. The chart below shows the relationship between the National Federation of Independent Businesses' (NFIB) survey on the proportion of members expecting to raise prices in coming months and the annual rate of core inflation. It suggests that conditions are normalising, with core inflation set to return to historical trends.   NFIB price intentions surveys suggest corporate pricing power is normalising   While concerns about the outlook for demand are a key factor limiting the desire for companies to raise prices further, a more benign cost backdrop has also helped the situation. The annual rate of producer price inflation has slowed from 11.7% to 2.2%, having dropped to just 0.3% year-on-year in June while import prices are falling outright in year-on-year terms. There are also signs of labour market slack emerging, with unemployment starting to tick higher and average hourly earnings growth slowing to 4.1% from near 6% just 18 months ago. Perhaps more importantly, non-farm productivity surged in the third quarter with unit labour costs falling at a 0.8% annualised rate. With cost pressures seemingly abating from all angles, this should argue for core services ex-housing, a component that the Fed has been keeping a careful eye on, to soften quite substantially over coming months.   Fed's "supercore" inflation should slow more rapidly   Energy and vehicle price falls to depress inflation Another area of recent encouragement is energy prices. The fear had been that the conflict in the Middle East would have consequences for energy markets but, so far, we have seen energy prices soften. Gasoline prices in the US have fallen 50 cents/gallon between mid-September and early November, leaving prices at the lowest level since early March. Gasoline has a 3.6% weighting in the CPI basket. Our commodity strategists remain wary, warning of the risk that an escalation in the conflict could lead to oil and gas supply disruptions from some key producers in the region, most notably Iran. For now though, energy prices will depress inflation rates and could mean at least one or two month-on-month outright declines in headline prices with lower energy prices limiting any upside potential from airline fares (0.5% weight in the CPI basket). On top of this, we expect to see new and used vehicle prices (combined 6.9% weighting in the CPI basket) being vulnerable to further price falls in an environment where car loan borrowing costs are soaring. New vehicle prices have risen more than 20% since 2020 amid supply problems and strong demand while used vehicle prices rose more than 50%, according to both the CPI measure and Manheim car auction prices. Prices for used cars have fallen this year but still stand 35% above those of 2020. Experian data suggests the average new car loan payment is now around $730 per month while for second-hand cars it is now $530 per month. With car insurance costs having risen rapidly as well (up 18.9% YoY with a 2.7% weighting in the CPI basket), the cost of buying and owning a vehicle is increasingly prohibitive for many households and we suspect we will see incentives increasingly capping the upside for vehicle prices. It is also important to remember that the surge in insurance costs is a lagged response to the higher cost of vehicles – and therefore insured value – and that too should slow rapidly (but not fall) over coming months.   Gasoline prices and oil prices surprise to the downside   Rent slowdown will be the big disinflationary force in early 2024 The big disinflationary influence should come from housing over the next couple of quarters. The chart below shows the relationship between Zillow rents and the CPI housing components. This is important because owners’ equivalent rent is the single biggest individual component of the basket of goods and services used to construct the CPI index, accounting for 25.6% of the headline index and 32.2% of the core index. Meanwhile, primary rents account for 7.6% of the headline index and 9.6% of the core. If the relationship holds and the CPI housing components slow to 3% YoY inflation, the one-third weighting that housing has in the headline rate and 41.8% weighting in the core will subtract around 1.3 percentage points of headline inflation and 1.7ppt off core annual inflation rates.   Rents point to major housing cost disinflation   On track for 2% inflation next summer There are some components on which there is less certainty, such as medical care, but we are increasingly confident that inflationary pressures will continue to subside and this means that the Federal Reserve will not need to raise interest rates any further. Next week’s October CPI report may not show huge progress with headline CPI expected to be flat on the month and core prices rising 0.3% month-on-month, but we expect headline inflation to slow to 3.3% in the December report with the annual rate of core inflation coming down to 3.7%. Sharper declines are likely in the first half of 2024. Chair Jerome Powell in a speech to the Economic Club of New York acknowledged that “given the fast pace of the tightening, there may still be meaningful tightening in the pipeline”. This will only intensify the disinflationary pressures that are building in an economy that is showing signs of cooling. We forecast headline inflation to be in a 2-2.5% range from April onwards with core CPI testing 2% in the second quarter. With growth concerns likely to increase over the same period, this should give the Fed the flexibility to respond with interest rate cuts. We wouldn’t necessarily describe it as stimulus, but rather to move monetary policy to a more neutral footing, with the Fed funds rate expected to end 2024 at 4% versus the consensus forecast and market pricing of 4.5%.   ING CPI forecasts (YoY%)
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Tide of Lower US Rates Propels EUR/USD Higher: A Look into 2024"

ING Economics ING Economics 16.11.2023 12:40
EUR/USD: Lifted higher by the tide of lower US rates US slowdown is central: Our forecast for a higher EUR/USD next year hangs wholly on the view that the US will slow down, inflation will ease and the Fed will be able to make monetary policy less restrictive. Currently we forecast 150bp of Fed easing starting next May/June. This is premised on tighter financial conditions finally weighing enough on aggregate demand to see US growth converge on the stagnant trajectories, especially in Europe. Our team forecast US growth at just 0.5% next year versus the consensus of 1.0%. Equally, our end year 2024 EUR/USD forecast of 1.15 is slightly above the current consensus of around 1.11. In terms of timing the trajectory, our current bias is that EUR/USD strength will become more apparent from the second quarter onwards. The dollar traditionally performs well at the start of the year and with the eurozone in recession, the first quarter may be too early to see a decisive turn higher in EUR/USD.     ECB could crumble: The headwinds to a EUR/USD rally largely stem from weak eurozone growth and the risk that the ECB chooses to cut rates alongside the Fed. This would limit the expected narrowing in yield differentials at the short-end of the curve. Our team forecast three quarters of negative eurozone growth (3Q23 to 1Q24 inclusive) and full-year 2024 eurozone growth at just 0.2%. We expect 75bp of European Central Bank (ECB) easing in 2024 starting in the third quarter, but clearly the risk is that the ECB eases earlier and the Fed later such that the starting pistol for the EUR/USD rally is never fired. Equally, a failure of European governments to agree on fiscal reform by year-end 2023 could see the re-introduction of the Stability and Growth Pact in early 2024 – an unwelcome arrival in a recession.   EUR/USD looks fairly valued:  Our medium-term fair value model suggests EUR/USD is fairly valued down at these lowly levels. In other words, there is not the kind of extreme undervaluation that has supported EUR/USD at these levels in the past. This really does build the case that if there is to be a EUR/USD rally, it will have to be driven by the dollar leg. Away from the Fed easing story there is also the risk of US fiscal deterioration and de-dollarisation – perhaps both slow-burn stories. There is also the small matter of the US election. Most commentators warn of a Trump 2.0 administration being ‘louder’. Depending on how the opinion polls progress, we presume any swing in favour of a second term for Donald Trump to be dollar positive – given the experience of the loose fiscal and protectionist policy agenda during his last stay at the White House.    
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Key Developments in Developed Markets: Fed's Potential Pushback and Rate Cut Expectations"

ING Economics ING Economics 12.12.2023 14:18
Key events in developed markets and EMEA next week There's growing evidence that tight monetary policy and restrictive credit conditions are having the desired effect on depressing inflation. However, neither the Federal Reserve nor Bank of England will want to endorse the recent ramping up of rate cut expectations in financial markets as both prepare to release decisions next week.   US: Pushback from the Fed The Federal Reserve is widely expected to leave the Fed funds target range at 5.25-5.5% at next week’s FOMC meeting. Softer activity numbers, cooling labour data and benign inflation prints signal that monetary policy is probably restrictive enough to bring inflation sustainably down to 2% in coming months, a narrative that is being more vocally supported by key Federal Reserve officials. The bigger story is likely to be contained in the individual Fed member forecasts – how far will they look to back the market perceptions that major rate cuts are on their way? We strongly suspect there will be a lot of pushback here. The steep fall in Treasury yields in recent weeks is an easing of financial conditions on the economy and there is going to be some concern that this effectively unwinds some of the Fed rate hikes from earlier in the year.  We expect the Fed to retain a relatively upbeat economic assessment with the same 50bp of rate cuts in 2024 they signalled in their September forecasts, albeit from a lower level given the final 25bp December hike they forecasted last time is not going to happen. We think the Fed will eventually shift to a more dovish stance, but this may not come until late in the first quarter of 2024. The US economy continues to perform well for now and the jobs market remains tight, but there is growing evidence that the Federal Reserve’s interest rate increases and the associated tightening of credit conditions are starting to have the desired effect. We look for 150bp of rate cuts in 2024, with a further 100bp in early 2025.

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