risk assets

Market picture The announcement of the debt ceiling deal triggered a natural spike in interest in Bitcoin on the expectation of increased retail interest in risk assets as institutional investors in Europe and America head off for a long weekend. Bitcoin traded as high as $28.4K at the start of Monday's Asian session but fell back to $27.8K by the beginning of European trading. Meanwhile, the top cryptocurrency has been rising daily since the 25th, pushing back from support at $25.8K, near the 200-week moving average. This move looks like an exit for speculators. However, the market's attention may shift to more market-heavy issues, such as slowing economic growth and high-interest rates. The bulls are now trying to get Bitcoin back above its 50-day moving average, which would signal a return to a medium-term uptrend.   The ability to close above $28.15 at the end of the day could attract more buyers to Bitcoin, while staying lower would be a reason to sell on the upside.   News background Commodity Futures Trading Commission (CFTC) commissioner Christy Goldsmith Romero said she is ready to regulate the crypto industry with the US Securities and Exchange Commission (SEC). Users of cryptocurrency exchange Tornado Cash have sued the US Treasury Department for imposing sanctions on the service, claiming that banning open-source software violates the US Constitution.ECB board member Fabio Panetta assured that the regulator would not have access to the personal data of digital euro holders (CBDC). He noted the need to balance ensuring privacy and combating money laundering and terrorist financing. High profitability enables stablecoin issuer Tether to venture into new business areas, according to the company's CTO Paolo Ardoino. Tether made a net profit of $1.48 billion in the first quarter, double that of the previous period.

Rates Spark: Rates volatility goldilocks continues Eurozone consumer inflation expectations will be the main data point to look out for today. Markets have become numb to central banks’ hawkish comments. Low rates volatility looks set to continue, benefitting risk appetite in other markets.   Range trades are a near-term catalyst to our USD-EUR rates tightening view The Saudi oil production cut and calm market conditions paving the way to another flurry of debt issuance are the two most salient bearish risks for core government bonds this week. That said, the Fed went into its pre-meeting quiet period with the probability of a 25bp hike on 14 June well below 50%, and we think there is little the European Central Bank (ECB) can say to really cause a hawkish rethink of its rates trajectory. We take as evidence the lack of market reaction to various officials – including Christine Lagarde and Joachim Nagel – stating that inflation remains too high. The main reasons, we think, are that markets are already pricing two 25bp ECB hikes by the end of the summer and that central banks have been explicit that economic data will determine the path for monetary policy.   Markets are already pricing two 25bp ECB hikes by the end of the summer We see this as a recipe for rates to remain within their range. Core bonds erased their early sell-off in the US session yesterday thanks to signs of a cooling service sector displayed in the ISM services reading. Is this enough to change the prevailing narrative? It isn’t, but Treasuries went into the release very close to the top of their recent range in yields which we suspect made short-term investors all the more enthusiastic about buying the morning dip. The same cannot be said of Bund yields, which started the week close to the bottom of their range, making them less appealing to range traders.   This state of play, high dollar and low euro rates, happens to contradict our expectation of narrowing rates differentials and we expect this dynamic to reverse. In the short term because the lack of market direction should limit further US Treasury sell-off and further Bund rallies, and later because tangible signs of a decline in core inflation occurring in the US are so far lacking in Europe. This should allow a fall in USD rates later this year, even as their EUR peers remain elevated for a while longer.     High but stable rates volatility is a boon for risk appetite The implication for markets outside of rates is positive. After a year of being tormented by the relentless rise in borrowing costs in 2022, few investors are sorry to see yields lacking in direction. Realised and implied volatility remain high compared to their 2021 levels, but well below their late 2022 peak. Until rates make a decisive break lower on a dovish pivot by central banks, current levels of volatility can be thought of as the new normal. This stabilisation has been enough to boost risk appetite in other markets. Whether lower rates volatility is the cause or another symptom of lower macro uncertainty, it has come with valuations in some risk assets that belie recession calls.     Sovereign spreads, much like some measures of swaption implied volatility, are approaching their lowest levels in a year       This is visible in many corners of financial markets. Eurozone sovereign spreads, much like some measures of swaption implied volatility, are approaching their lowest levels in a year. Similarly, although the factors may also include money market dynamics, swap spreads are shedding their risk premium acquired during the latest bout of US regional banking stress. At the front-end of the curve, the credit premium received by investors is painting an upbeat picture. We will stop short of extrapolating this to other markets, but a continuation of the current rates volatility status quo seems to suit most markets.         Today's events and market view The release most likely to move euro markets today is the ECB’s consumer expectations survey and more specifically the questions on their inflation outlook. Eurozone retail sales are expected to edge modestly up after their slump in March. There will also be construction PMIs to look out for from Germany and the UK.   Bond supply takes the form of a 30Y gilt sale from the UK, to which Germany and Austria will add respectively 10Y/23Y linker and 10Y/13Y bond auctions. The EU has also mandated banks for the sale of 7Y and 19Y debt via syndication.   Klass Knot, Mario Centeno, and Boris Vujcic are on the list of ECB speakers for today.   Weak factory orders in Germany released this morning add to the sense of anemic growth. We think this is more likely to result in an even more inverted yield curve in the near term rather than significantly lower rates overall as the ECB is laser-focused on its inflation fight.    

In my morning forecast, I highlighted the level of 1.0800 and recommended making entry decisions based on it. Let's look at the 5-minute chart and analyze what happened there. The rise and formation of a false breakout at 1.0800 provided a sell signal for the euro, but there was no significant downward movement. The technical picture remained largely unchanged in the second half of the day.       Everyone awaits the US inflation figures, which will determine the market and the Federal Reserve's actions. If prices drop more than economists' expectations, the euro will have a chance to continue rising against the US dollar, as the central bank is likely to take the first pause in the interest rate hike cycle since 2021. If inflation remains high, we can expect renewed pressure on EUR/USD and a decline in the pair. In that case, I will act on the decline and the false breakout around the support level of 1.0767, formed based on yesterday's close and where the moving averages, favoring buyers, are located.   This will provide an opportunity to enter long positions with the target of another rise towards the level of 1.0800. A breakthrough and top-down test of this range are necessary for buyers, as it will strengthen the demand for the euro, creating an additional entry point for increasing long positions with an update to the next level of 1.0830. The ultimate target remains around 1.0870, where I will take profits. In the case of a decline in EUR/USD and the absence of buyers at 1.0767, the pressure on the euro will return. Therefore, only the formation of a false breakout around the next support level of 1.0734, the weekly low, will provide a signal to buy the euro.   I will open long positions after a rebound from 1.0705, with a 30-35 point upward correction target within the day. To open short positions on EUR/USD, the following is required: Bears managed to defend the market around the resistance level of 1.0800, but there was no significant downward movement. The US inflation data will determine everything. However, considering the bullish market with selling pressure in the second half of the day, it is better to take your time.   I will act only after another unsuccessful consolidation above the resistance level of 1.0800. A false breakout at this level will provide a sell signal capable of pushing the pair back to 1.0767, where the moving averages favoring bulls are located. Consolidation below this range and a reverse test from below to above will lead straight to 1.0734. The ultimate target will be around 1.0705, where I will take profits.       If EUR/USD moves upward during the American session and there are no bears at 1.0800, which is likely to be the case, the demand for the euro will only strengthen, potentially leading to a more powerful upward surge in the pair. In that case, I will postpone short positions until the new resistance level of 1.0830.   Selling can be done there, but only after an unsuccessful consolidation. I will open short positions immediately on a rebound from the maximum of 1.0870, with a 30-35 point downward correction target.   The Commitment of Traders (COT) report for June 6 showed a decrease in long positions and a slight increase in short positions. Despite this, the Federal Reserve's decision on interest rates this week can significantly change the market dynamics, so paying much attention to the abovementioned changes may be optional. If the Fed decides to pause the rate hike cycle, the euro will gain significant weight, and the US dollar will weaken.   Along with the European Central Bank's aggressive policy, despite the first signs of a slowdown in underlying inflationary pressure, all of this will lead to a continued rise in risk assets against the US dollar. According to the COT report, non-commercial long positions decreased by 5,757 to 236,060, while non-commercial short positions increased by 1,457 to 77,060. The overall non-commercial net position decreased to 158,224 from 163,054 by the end of the week. The weekly closing price decreased to 1.0702 from 1.0732.   Indicator signals: Moving averages. Trading occurs above the 30-day and 50-day moving averages, indicating a likelihood of the euro's rise. Note: The author considers the period and prices of the moving averages on the hourly chart (H1), which differs from the general definition of classical daily moving averages on the daily chart (D1).  

Asia Morning Bites China's monetary stimulus and lower US inflation provide a positive backdrop for risk assets ahead of tonight's FOMC meeting.   Global Macro and Markets Global markets:  Equities seemed to like the continued decline in US inflation yesterday, as it bolsters the case for a pause from the Fed (next decision at 02:00 SGT Thursday). The S&P500 rose 0.69% yesterday, and the NASDAQ added another 0.83%. Chinese stocks also rose, helped by yesterday’s unexpected PBoC rate cut. Still, despite the lower inflation print, US Treasury yields rose some more – the yield on 2Y notes rose 8.9bp to 4.666%, and the 10Y bond yield rose 7.8bp to 3.813%. Once the Fed is out of the way, and the market has settled, perhaps with an even slightly higher bond yield, this might well feel excessively high, given that inflation for July will probably come in at the low 3% level. EURUSD rose a little yesterday, reaching 1.0789, Other G-10 currencies also made gains, though the JPY continues to look soft at 140.18.  The KRW was the standout in Asia yesterday, gapping lower to 1271.50, possibly helped by hawkish comments from the latest BoK minutes. Strong labour data just out will also likely help (see below).   G-7 macro: Yesterday’s US inflation figures for May came out more or less in line with expectations. Headline inflation dropped to just 4.0% from 4.9%, while the core fell a little less, reaching 5.3% (it was 5.5% previously). James Knightley’s note on what this means is worth a close read. But the short version is that it boosts the chances of a Fed pause tonight – even if they indicate further hikes in the dot-plot (we don’t think they will ultimately deliver).  US May PPI data due out should add to the case for falling pipeline inflation pressures. UK April industrial production will not make pleasant reading, though the index of services could be a bit stronger. The ECB meets to decide on rates tomorrow. There is a wide consensus for a further 25bp of tightening.   South Korea: The jobless rate unexpectedly fell to 2.5% in May (vs 2.6% in April, 2.7% market consensus). Employment of services such as whole/retail sales, recreation, and transportation, led the improvement. One interesting thing is that job growth in ICT and professional, scientific& technical activities has been particularly strong over the past several months, despite the recent weakness in the semiconductor business. We think this is not directly related to semiconductor manufacturing itself but more related to platform services and software development, including AI technology. We believe that the tech sector has held up relatively well. Meanwhile, the construction industry shed jobs for the second consecutive month, and real estate also cut jobs.  We think that despite weakness in manufacturing and construction, service-led labour market improvements have continued, and this probably supports the hawkish tone of the BoK. In a separate data release, import prices dropped significantly to -12.0% YoY in May (vs -6.0% in April), mostly due to falling commodity prices. We expect consumer inflation to decelerate further in the coming months and to reach the 2% range as early as June.     What to look out for: FOMC meeting South Korea unemployment (14 June) India Wholesale prices (14 June) US PPI inflation and MBA mortgage applications (14 June) FOMC policy meeting (15 June) New Zealand GDP (15 June) Japan core machine orders (15 June) Australia unemployment (15 June) China industrial production and retail sales (15 June) Indonesia trade (15 June) India trade (15 June) Taiwan policy meeting (15 June) ECB policy meeting (15 June) US retail sales and initial jobless claims (15 June) Singapore NODX (16 June) BoJ policy meeting (16 June) US University of Michigan sentiment (16 June)

Rates Spark: Raising the hawkishness bar A hawkish pause from the Fed, but the higher dots add to its degree. Market rates have reason to rise more. The bar for the ECB to surprise to the hawkish side today and move longer rates sits high, with the market apparently well-priced already.   Market rates have enough here to push higher, and the front end will feel tighter even without a hike The Fed has latched on to the theme that has dominated the market mindset in the past number of weeks, namely that the US economy continues to refuse to lie down. This has helped risk assets, as by implication default risks that would typically evolve from a recession have been kept at bay, helping credit spreads to tighten and equity markets to perform. There has also been an easing in measures of system risk, especially as immediate banking sector angst has been downsized. This overall combination has allowed market rates to ease higher, driven by higher real rates, which in turn are a sign of strength.   Initial comments from the Fed do not negate these themes, and in fact push for more of the same. While this is more reflective of the new “dots” than anything else, it in any case pushes in the direction for higher market rates ahead. We continue to position for the 10yr to head to the 4% area, and it would not look wrong if it were to drift above for a period, at least until the illusive macro slowdown is a tad more clear-cut than now. We still expect the 10yr to be much closer to 3% by the end of the year but for now we see yields rising higher first.   There was no particular mention of the changing liquidity circumstances. Currently there is amble liquidity, with bank reserves on the rise (up from US$3trn to US$3.4trn), and still over US$2trn going back to the Fed on the reverse repo facility. The US Treasury has only slowly rebuilt its cash balance at the Fed since the debt ceiling was suspended, so the impact of less prior bills issuance and more bank support has dominated the ongoing quantitative tightening programme. Ahead, some US$500bn off liquidity will get drained out of the system as the Treasury rebuilds its balance through net bills issuance. We expect from that a combination of lower bank reserves and lower cash on the reverse repo facility.   This will make it feel like there has been some tightening in conditions, even if not in levels (as the Fed has not hiked).   Still hawkish, but harder to regain traction further out

GBP: Sterling to hold gains into next week's CPI data Sterling continues to hold gains as the market rigidly holds onto aggressive Bank of England tightening expectations. This year sterling's correlation with risk assets had fallen, suggesting perhaps that it should not be at the forefront of a risk rally. However, as above, we think the dollar environment is softening and we do not want to stand in the way of a GBP/USD rally.  Looking at the charts it seems there is 'fresh air' between current levels (1.2750/1.2800) and 1.3000 – suggesting the latter beckons. For EUR/GBP, the hawkish ECB helps strengthen the support at 0.8550, although next week's release of the UK June CPI will probably be the next big driver here, ahead of an expected 25bp BoE rate hike next Thursday.

FX Daily: Dollar trapped between inverted curves and rallying equities There has been little follow-through from the dollar selling we saw late last week. Currently, global markets present a curious picture of steeply inverting yield curves – which occasionally forewarn recession – but bid equity markets. Which market has it right? We tend to think the dollar will come lower in the second half, but again timing is everything.   USD: Dollar trapped in the middle of inverted curves and risk rally FX markets are relatively quiet following yesterday's public holiday in the US. Risk assets are marginally softer after Chinese authorities only cut the 5-year Loan Prime Rate by 10bps – disappointing those looking for more aggressive support from lower mortgage rates to China's property sector. USD/CNH pushing back up to 7.18 has kept USD/Asia bid and provides a mildly bullish undercurrent to the dollar as the European session gets underway. Softening the lens a little we see the dollar trapped between two stories and reflected in its 2% gains against the yen and 2% losses against sterling and commodity currencies over the last month. Those two stories are: i) steeply inverting yield curves as central banks try to squeeze inflation out of economies and ii) rallying equities on the view that recessions will be mild (perhaps because of low unemployment). Our big picture call here is that US disinflation comes through in the third quarter, bearish US yield curve inversion switches to bullish steepening, and the dollar falls more broadly. But we are not there yet. Back to the short term, there is only second-tier US data today in the form of housing starts and we have the Fed's James Bullard speaking at 1230CET today. He is one of the most hawkish Fed governors, but not an FOMC voter this year. Presumably, he may shed some light on why the Fed could hike by another 50bp this year (consistent with the latest Dot Plots), but that may not move the dollar needle much. DXY is to trade well within a 102.00-103.00 range and expect USD/JPY to continue nudging higher. It increasingly looks as though Japanese authorities will be called into FX intervention again near the 145 level.

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.

The IMF estimated the size of the sector in more detail by looking at the respective share of the Global Financial Assets for each sub-sector of NBFIs.   Investment funds are the most important NBFI sub-sector representing 12% of global financial assets Insurance companies and pension funds follow, at 9% of the global financial assets       Overall, these institutions now represent a 49.2% share of total global financial assets, surpassing banks at 37.6%. The rest of the market is composed of central banks and Public Financial Institutions.   The NBFI sector has more than doubled since 2008   NBFIs represent 63% of national financial assets in the US. In the eurozone, the sector is less significant though it has still doubled in size since the global financial crisis.   Total NBFI assets in the euro area have doubled since 2009 Euro area NBFI assets diminished in 2022 as the sector sold higher risk assets acquired during the low interest rate period  

Market rates are feeling the pressure. Risk assets have been bought into, and inflation is not calming fast enough. Central banks are piling further pressure on them. The US 10yr Treasury yield won't look right until it hits 4% and can take out the prior high. The 10yr Bund yield should get back to 2.75%, at least, and can still look up, possibly to about 3%   The journey for 10yr rates is back to March highs Market rates peaked in March this year. At the time, there was what looked like a relentless rise in rates underway, only to be undercut by the sudden and unexpected implosion of Silicon Valley Bank (SVB), with echoes in Europe as Credit Suisse was forced into a merger. There have been ripples of concern since, but apart from another few manageable banking causalities in the US, there has been a calming of nerves. In fact, we managed to morph from a state of material concern for the system to one of outright 'risk-on'. The coincident rise in market rates is an outcome of this. Plus there's sticky inflation in both Europe and the US (and beyond), and in the US an economy that just won’t lie down. So where now? On the one hand, forward-looking indicators are in a recessionary state, small bank vulnerabilities remain, and lending standards are tight. The eurozone has moved into a state of technical recession, and China is showing only a subdued reopening oomph. That, together with the cumulative effects of rate hikes already delivered, plus the negative real wage growth environment, should ultimately place material downward pressure on market rates as we progress through the second half of 2023. A peaking out for official rate hikes from both the Federal Reserve and the European Central Bank in the coming months would mark an important point in the cycle. From that point on, market rates should be on the decline, and yield curves should be in a dis-inversion mode. But we are not at that point just yet. The latest US core PCE number at 4.9% reminds us that the US is still a "5% inflation economy". We think this will change (inflation will ease lower), but for now, it is what it is until dis-proven. In the eurozone, there has been a material easing in inflation rates, but the headline reading is still high, at 5.5%. UK inflation seems to have stopped falling, but it is still close to 9%, requiring the Bank of England to re-accelerate hikes. In the US, the latest consumer confidence number for June popped back out to 109.7 (versus 100 at neutral). All of this places upward pressure on market rates, and these factors are likely to sustain the upward pressure, at least for as long as an underlying oomph factor remains in play.  

CEE: Disinflation continues across Central and Eastern Europe, opening up the possibility of central bank rate cuts. However, lower inflation does not necessarily mean faster rate cuts. The local story will increasingly create divergence across the region.   Commodities: We have revised lower our oil forecasts for the latter part of the year. A more hawkish Federal Reserve, limited speculative appetite (given the uncertain outlook), robust Russian supply and rising Iranian supply all suggest that the market will not trade as high as initially expected.   FX: The dollar downtrend is "on hold" as markets await key data to determine the new peak for Fed rates and the timing of rate cuts. EUR/USD may trade around or slightly below 1.10 in the third quarter as the US data story fails to turn clearly USDnegative, but medium-term undervaluation and a forecasted drop in US short-term rates suggest a climb to 1.15-1.18 in 4Q23/1Q24 remains possible.   Rates: Market rates are feeling the pressure. Risk assets have been bought into, and inflation is not calming fast enough. Central banks are piling further pressure on them. The US 10yr Treasury yield won't look right until it hits 4% and can take out the prior high. The 10yr Bund yield should get back to 2.75%, at least, and can still look up, possibly to about 3%.

EUR: Looking at 1.1100 As discussed above, equity flows may be partially explaining why EUR/USD is drifting higher even though some key inputs are barely moving. The default view will be that EUR/USD is unlikely to break above 1.1100 since the Fed is still hawkish and risk assets have yet to adjust to the much more restrictive monetary policy settings around the world. It is probably dangerous to expect a range break-out, but if it were to occur this week, tomorrow's US June CPI figure would probably be the catalyst. The eurozone calendar is quite light today – just the July ZEW investor expectations survey at 11CET – and we have the lone ECB speaker of Francois Villeroy de Galhau at 10CET who is unlikely to move the needle much on current market pricing of two more 25bp ECB rate hikes by October. We have been here before and should not get over-eager on a possible range break-out, but we could see EUR/USD drifting closer to the year's highs near 1.1100.  

Metals – Edging up on dollar weakness Spot gold rose to its highest level in almost four weeks, while industrial metals edged higher yesterday as easing inflation in the US pushed the dollar index to its lowest level since April 2022. Rising market speculation that the Federal Reserve's interest rate hikes may soon be nearing an end further lifted overall optimism across risk assets. China released its preliminary trade data for metals yesterday, which shows total monthly imports for unwrought copper falling 16.4% YoY to 449.6kt in June amid weak demand from the property market. Higher domestic production of the metal also impacted demand for imported copper. Cumulative unwrought copper imports fell 12% YoY to 2.6mt in the first half of the year. In contrast, imports of copper concentrate rose 3.2% YoY to 2.13mt last month, while year-to-date imports rose 7.9% YoY to 13.4mt. In ferrous metals, iron ore monthly imports rose 7.4% YoY to 95.5mt, while cumulative imports are also up 7.7% YoY to a total of 576mt in the first half of the year. On the exports side, China’s unwrought aluminium and aluminium products shipments fell 19% YoY to 492.6kt last month, while year-to-date exports declined 20% YoY to 2.81mt in the first half of 2023. Exports of steel products jumped 31% YoY to 43.6mt over the first half of the year. Recent data from China Iron and Steel Association (CISA) shows that steel inventories at major Chinese steel mills fell to 15.9mt in early July, down 7.6% compared to late June. Meanwhile, crude steel production at major mills fell marginally by 0.3% to 2.24mt/d in early July.

FX Daily: How much more fuel in the disinflation tank? Last week’s US disinflation shock altered the FX landscape, but a few days without key data releases will tell us whether that impulse can keep the dollar on the back foot as the FOMC risk event draws nearer. EUR/USD appears a bit overstretched in the short term and could face a correction this week.   USD: Some caveats to the bearish narrative On Friday, we published FX Talking: The dollar’s break point, where we discuss our updated views on G10 and EM currencies and present our latest forecasts. The radical shift in the FX positioning picture since the US CPI and PPI releases last week now forces a reassessment of the dollar outlook. The Commodity Futures Trading Commission (CFTC) data on speculative positioning offers little help in understanding how much dollar positioning has changed since the latest reported positions were as of Tuesday, before the inflation report. Back then, the weighted aggregate positioning against reported G9 currencies (i.e., G10 excluding SEK and NOK) had already inched into net-short territory (-2% of open interest, in our calculations). When making the parallel with the November-December 2022 dollar decline, positioning shows a key difference. At the end of October 2022, markets were still speculatively long on the dollar (around 10% of open interest against CFTC-reported G9). Another important factor – especially for EUR/USD – is the degree to which other central banks outside of the US can still surprise on the hawkish side, which is significantly lower than it was last autumn. These caveats to the rather compelling bearish dollar story mean that it may not be one-way traffic from here in FX, even if we see the dollar weaken further into year-end. On the fundamental side, the disinflation story puts risk assets on a sweet spot, favours a re-steepening of the US yield curve and should make pro-cyclical currencies more attractive. However, the Federal Reserve may not turn into a USD-negative that swiftly. Our US economist still sees a 25bp hike next week as likely. It is fully priced in, but will the Fed be ready to throw the towel on more hikes just yet? Core inflation is declining, but the jobs market remains very tight and other economic indicators remain resilient. The dot plot is still showing another hike before a peak and Fed Chair Jerome Powell may prefer to err on the hawkish side, especially through a rate cut pushback (first cut priced in for the first quarter of 2024). This week will be interesting to watch since the lack of tier-one data in the US will offer a clue on how FX markets will trade from now on; the question is whether investors now see enough reasons to add short positions on the dollar ahead of the FOMC or take a more cautious approach. The latter – which appears marginally more likely in our eyes – may see the dollar reclaim some portions of recent losses. DXY could find some support after climbing back above 100.00.

The Commodities Feed: All eyes on the Fed The Federal Reserve is expected to raise rates by 25bp today, and markets will be on the lookout for any signals suggesting this could be the central bank's final hike or whether there could be more still to come.   Energy – Fed key for short term price direction Sentiment in the oil market has improved with ICE Brent settling a little more than 1% higher yesterday. The market is more optimistic following China’s Politburo meeting,  where there were promises for more support measures for the domestic economy. However, up until now, there haven't appeared to be any actual policies that have been announced. Overnight, the API also released US inventory numbers which showed that US crude oil inventories increased by 1.32MMbbls, whilst crude stocks at Cushing fell by 2.34MMbbls. On the product side, gasoline inventories fell by 1.04MMbbls, whilst distillate stocks increased by 1.61MMbbls. The report was a bit of a mixed bag, with little in the way of a strong takeaway from the numbers. The more widely followed EIA report will be out later today. The market will be watching closely the outcome of the FOMC meeting later today. Expectations are that the Federal Reserve will hike rates by 25bp, which could very well be the last hike in this cycle. However, any signal from the Fed that they have more to do will likely put some downward pressure on risk assets, including oil. The Saudis will be happy to see Brent trading back above US$80/bbl with their additional voluntary cut of 1MMbbls/d starting to have its desired effect. However, the broader OPEC+ cuts are leading to some distortions within the market (tightness in medium sour crudes) and this is evident in the unusual discount that Brent continues to trade at relative to Dubai. However, the decision that Saudi Arabia will need to make in the coming weeks is whether they will roll this additional cut into September or start to unwind it. The recent price strength might give the Saudis the confidence to start unwinding these cuts, but expectations will have to be managed and they will have to be careful how they go about it – too aggressively and it could put renewed pressure back on the market.

FX Daily: Fed patience provides breathing room for risk assets The market reaction to last night's FOMC statement was a mildly positive one, as Chair Powell's acknowledgement that the Fed could afford to be a little patient saw US yields and the dollar soften slightly. Today, all eyes will be on the ECB, where a 25bp hike is widely expected along with the door being left open for another hike in September.   USD: A little early to chase the dollar lower In the end, the dollar tracked US yields and marginally softened after yesterday's FOMC rate decision and press conference. Fed Chair Jerome Powell delivered another credible performance, and it seemed that markets – perhaps because of positioning – latched onto comments that the Fed "could afford to be a little patient" as a result of all the tightening implemented so far. US two-year yields edged some 7-8 bps lower, and December 2024 futures contracts priced Fed Funds some eight ticks lower at 4.07%, embracing five 25bp cuts in 2024. One of the clearest messages coming through from the press conference was that Chair Powell felt the Fed was "not in an environment where we want to provide a lot of forward guidance". In other words: listen to the data, not the Fed. On that subject, he highlighted that by the time of the next meeting on September 20th, the Fed would have two new CPI reports, two new job reports, and the Employment Cost Index (which will be released tomorrow).  While the dollar is a little lower today post-Fed, we would not chase the move just yet and prefer to take our cue from the data, starting with tomorrow's ECI. As we discussed in our FOMC review, the carry trade environment will still be popular and with overnight deposit rates at 5.25%, the dollar is clearly not a funding currency. Beyond the ECB meeting today, the US calendar should see some downward revisions to second quarter GDP, durable goods orders, and initial jobless claims. Of these, claims might be the most important given the ongoing need to see tight conditions ease in the US labour market. Barring any hawkish surprise from the ECB today, DXY should trade within a 100.60-101.20 range.

FX Daily: Diverging G3 trends dominate Closing the week, we have the Japanese yen a little stronger as the BoJ softens up YCC control, the dollar is steady-to-stronger on good US activity data, and the euro is weaker as the ECB throws a September rate hike into doubt. After the BoJ press conference, today's highlight will be the US Employment Cost Index data. A soft number could hit the dollar.   USD: The ECI will be in focus today The combination of some stronger US activity data and some independent euro weakness on the back of yesterday's ECB meeting has seen the trade-weighted DXY dollar push a little higher. DXY would be even higher were it not for the lower USD/JPY we have seen today on the back of the Bank of Japan's tweak to its Yield Curve Control (YCC) target.  Regarding the BoJ, we think the market is right to have taken USD/JPY a little lower after this surprise adjustment to how it manages its 10-year Japanese government bond (JGB) yield target. What has probably prevented USD/JPY from dropping harder are the new BoJ core CPI forecasts, where FY24 and FY25 CPI are still only forecast at 1.9% (April forecast 2.0%) and 1.6% (1.6%) respectively. This hardly provides a firm foundation to conclude that CPI will now sustainably run near 2.0%. Instead, the tweak to the YCC programme may reflect BoJ Governor Kazuo Ueda's preference to take baby steps away from the heavy control of the JGB market - i.e. maybe he's more of a free marketeer.  However, we do think the drop in USD/JPY might get some support from the dollar side today. Undoubtedly, US activity data has been holding up well, and based purely on the activity data alone one would argue that the Fed had the strongest case for another rate hike, yet Fed Chair Jerome Powell acknowledges that US monetary policy is already in restrictive territory and the focus is on disinflation.  On Wednesday, Powell said there would be important data prints before the September FOMC meeting – two CPI prints, two jobs reports and the Employment Cost Index (ECI). Well the second-quarter ECI figure is released today and is expected at 1.1% – a drop from 1.2% in the first quarter and a peak of 1.4% in the first quarter of 2022. My colleague James Knightley thinks the risks are skewed to a sub-consensus 1.0% reading today given the softer average hourly earnings and survey evidence both from the Fed's Beige Book as well as the NFIB data that the US labour market is coming better into balance. A soft ECI number can wipe out the final 8bp that is priced for the US tightening cycle this year and will probably knock the dollar 0.5-1.0% lower. This would be a good story for risk assets, where both the Fed and seemingly the ECB would be closer to ending tightening cycles. If we are right with our call on the ECI, DXY could head back to yesterday's low near 100.50.

FX Daily: US Treasury wobble unnerves risk assets A sell-off at the long end of the US Treasury market has cast a shadow over risk assets and hit cyclical currencies. The dollar has been the main beneficiary. Expect focus to very much remain on the US bond market into next week's quarterly refunding. For today, attention is on whether the BoE hikes 25bp or 50bp and how Brazilian assets react to the 50bp rate cut.   USD: Tracking Treasuries Wednesday's session was all about the US bond market and the sell-off at the long end of the curve. US 30-year Treasury yields were briefly 15bp higher. And far from the benign bullish disinversion of the curve we saw after the soft June CPI print, yesterday's move was a more negative bullish steepening. Higher risk-free rates hit US growth stocks (Nasdaq -2%) and also hit 'growth' currencies, such as the commodity complex and the unloved Scandi currencies. At the heart of yesterday's move was the US fiscal story. Despite the Democrat administration and its supporters in the media decrying Fitch's decision to remove the sovereign's AAA status on Tuesday evening, there is genuine concern over US fiscal dynamics. And it looks like the Fitch release was carefully timed. Yesterday also saw a slightly higher than expected US quarterly refunding announcement, where $103bn of 3, 10, and 30-year bonds will be sold next week. The fact that fiscal dynamics were in play yesterday was reflected in wider US asset swap spreads (Treasuries underperforming the US swap curve) and the US yield curve steepening. As above, higher risk-free rates are providing greater headwinds to risk asset markets - including equities. We are also seeing some slightly higher cross-market volatility readings which may prompt investors to partially de-risk from carry trade strategies (good for the Japanese yen and Swiss franc on the crosses, bad for the high yielders). We will also be interested to see how the Brazilian real performs today after Brazil's central bank started its easing cycle last night with a 50bp cut and promised similar magnitude cuts over coming meetings. The currency could edge a little lower today given the international environment. While the US Treasury story will be with us into next week's auctions, the focus today will be on the initial jobless claims (these have been moving markets) and the services ISM index. Barring a significant rise in claims or a big dip in the services ISM, it looks like the dollar will hang onto recent gains into what should be a decent US July nonfarm payrolls report tomorrow.    DXY could grind its way toward the 103.50 area.  

FX Daily: Dollar benefits from a lack of alternatives The US remains on an encouraging disinflation track, but the dollar is not turning lower. This is, in our view, due to a lack of attractive alternatives given warning growth signals in other parts of the world (such as the eurozone and China). Evidence of a US economic slowdown is needed to bring USD substantially lower.   USD: Disinflation not enough for the bears July’s US inflation numbers released yesterday were largely in line with expectations, reassuring markets that there are no setbacks in the disinflationary process for now. Core inflation inched lower from 4.8% to 4.7%, while the headline rate suffered a rebound (from 3.0% to 3.2%) due to a reduced base effect compared to previous months, which was still smaller than the consensus of 3.3%. With the exception of resilience in housing prices, price pressures clearly abated across all components. All in all, the US report offered reasons for the Fed and for risk assets to cheer, as the chance of another rate hike declined further. Equities rallied and the US yield curve re-steepened: the dollar should have dropped across the board in this scenario. However, the post-CPI picture in FX was actually more mixed. This was a testament to how currencies are not uniquely driven by US news at the moment. The Japanese yen drop was not a surprise, given abating bond and FX volatility, equity outperformance and carry-trade revamp, but FX markets seemed lightly impacted by CPI figures and the subsequent risk-on environment, as many high-beta currencies failed to hang on to gains. From a dollar point of view, we think the recent price action denotes a reluctance to rotate away from the greenback given the emergence of concerning stories in other parts of the world. This is not to say that the activity outlook in the US is particularly bright – jobless claims touched a one-month high yesterday, and the outlook remains very vulnerable to deteriorated credit dynamics – but if economic slowdown alarms are flashing yellow in Washington, they are flashing amber in Frankfurt and Beijing. Chinese real estate developer Garden reported a record net loss of up to $7.6bn during the first half of the year yesterday, at a time when China’s officials are trying to calm investors’ nerves about another potential property crisis. Back to the US, PPI and the University of Michigan inflation expectation figures out today will clarify how far the disinflation story has gone in July, but we still sense a substantial dollar decline is not on the cards for the moment, or at least until compelling evidence of slowing US activity makes the prospect of Fed cuts less remote. DXY may consolidate above 102.00 over the next few days.

Rates Spark: Let’s start talking louder about 4.5% Let's talk louder about 4.5%! There has been a consolidation of the market discount for a soft landing. High yield has been an outperformer and the big talk has been of elevated re-financing risks as rates remain higher for longer. Given that and the latest data, there is still an upside for market rates to come, especially in longer tenors.   Enough from the data to tempt the US 10yr towards 4.5% Key levels were hit on the US curve on Tuesday: 4.25% for the 10yr and 5% for the 2yr. Then there has been a brief consolidative theme, but only for more bond weakness to show overnight, with the 10yr hitting 4.3%. That is within spitting distance of last October's yield highs. Risk assets cannot quite decide whether to go risk-on or risk-off. It still feels biased to a risk-off tone in net terms. The issue here for risk assets is how to interpret the notion of a soft landing. On the one hand, it's good as it implies minimal default elevation. On the other, it also implies less room for rate cuts and, more damaging, the maintenance of elevated official rates for longer. This is a growing issue for players that need to get some re-financing done, as this is only going to be at more penal funding rates relative to what was obtained over the past 3-5 years (and further back too). The bulk of this has to do with the robustness of the US economy. This is the main driver behind the paring back of future rate cuts as discounted by the strip. It’s also showing up in a delay on the point at which the Fed is discounted to begin cutting rates. But then, on the very front end, there has been a pullback in the expectation for more rate hikes. Most of this has come from the significant fall in headline inflation and also in core inflation (albeit less dramatically so). That, in turn, has allowed the Fed to get less fussed over pushing the funds rate higher. Keeping it higher for longer is what squares the circle here in terms of the market discount. The rise in the 10yr Treasury yield reflects this, and it is a rationale for the 10yr Treasury yield to maintain an upward-looking profile, at least until this dynamic meaningfully changes. Latest data pushes in the same direction. Industrial production came in at 1% on the month, and capacity utilisation rose, which typically does not happen to an economy facing into an imminent recession. Even the latest housing market data came in on the firm side. Basically, July has followed the June data so far as being very much 'glass half full' for the economy. Not even an economy that seems to be landing at all. Hence the logic for market yields to hold on up here for a period. The 10yr can hit 4.5% unless some dramatic tilt happens.   The 10y UST's October yield highs are close   Today's events and market view The FOMC minutes did not contain anything particularly surprising. The key passage was that “most participants continued to see significant upside risks to inflation, which could require further tightening of monetary policy". Limited summer trading is likely amplifying market reactions, but the bias for rates remains to the upside.  There are only a few data points of note on today’s calendar. However, the initial jobless claims data has, in the past, been a source of knee-jerk reactions. With initial claims seen somewhat lower at 240k, the market seems to seek confirmation for the story of economic resilience. The other data point is the Conference Board’s Leading Index, seen posting its 16th consecutive contraction. It has been crying wolf for some time now. The eurozone will release its trade balance for June. French short- to medium-term bond and inflation-linked bond auctions make up today’s government bond supply.

FX Daily: Treasury slide keeps markets nervous This week's highlights include the Fed's Jackson Hole symposium, the 15th BRICS summit and flash PMIs for August. The steady slide in US Treasuries presents a headwind for risk assets and should keep the dollar in demand.\   USD: Treasury slide supports the dollar It has been a quiet start to the week for FX markets. Chinese authorities have delivered another rate cut – but this time the one-year loan prime rate has been lowered 10bp to 3.45%, while the 5-year loan prime rate has been unexpectedly left unchanged. The latter rate is seen as more important to Chinese mortgage markets and raises questions about how China plans to stimulate demand in that sector. The rate cut did not see large moves in the renminbi, and the ongoing low USD/CNY fixings suggest Chinese authorities are trying to draw some kind of line in the sand near 7.35. Unlike the Japanese, who are very transparent with their FX intervention activities, it is hard to discern whether Chinese authorities are intervening to sell dollars near current levels. However, with China employing monetary stimulus, expect the renminbi to stay soft and remain a popular funding currency. The dollar looks set to hold onto its gains this week. In focus will be Friday's speech from Fed Chair Jay Powell at the Jackson Hole symposium. This comes at a time when US 10-year yields are closing in on 4.30%, and our rates strategy team favours 4.50%. Intriguingly, the team notes that the US 10-year yield correlates most with the pricing of the policy rate four or five years forward. In other words, the Treasury sell-off is less about the terminal rate for this tightening cycle and more about where the Fed Funds rate settles under more normal conditions. Chair Powell could shed some light on this on Friday. The bottom line, however, is that it looks too early for the Fed to sound the all-clear on inflation and the dollar probably holds its gains.  DXY is holding gains above the 100-day moving average at 103.20 and can probably edge up to 104.00 this week. Additionally this week, look out for headlines from the BRICS summit (taking place August 22-24) in South Africa. The topic of BRICS expansion tops the agenda and inevitably will raise questions over the threat of de-dollarisation. Any evidence of that is very scant so far, as we note in our full report here.  

EUR: Another batch of soft PMIs? Before ECB President Christine Lagarde's speech on Friday, the highlight in the eurozone this week will be Wednesday's release of flash PMIs for August. Currently, gloom is descending on the European outlook, including the re-introduction of Germany's description as the 'sick man of Europe'. Let's see whether the manufacturing PMIs deteriorate any further and also whether services PMIs cross decidedly into sub-50 territory. EUR/USD is starting to look quite comfortable below 1.09 and below support at 1.0835/45 could make a dip down to the 1.0775 area. Certainly, with US Treasury yields pushing ahead and proving a threat to risk assets – and China still fragile – EUR/USD will struggle to make it back above the 100-day moving average at 1.0930.

Rates Spark: Not the end of the story Yields dropped after very weak PMIs. In the US, the narrative of economic resilience that has been the main driver of higher rates over recent months has been challenged. It is but one data point and Fed Chair Powell will also have a word to say at Jackson Hole.   Disappointing PMIs upends the resilience narrative The broader rise in rates had largely been driven by the narrative surrounding a surprisingly resilient US economy. So, when that narrative gets challenged, a large market reaction can be expected. For the US, PMIs would not have been the usual suspect, but when the disappointment in the data is as large as today – and also happening on a global scale – the market takes note. The UST curve bull flattened with 10Y UST yields falling more than 13bp to below 4.2%. With the data miss as large as it was, the possibility of Fed cuts was priced back in, and the December 2024 SOFR future's implied yield dropped 12bp. The very near-term policy outlook did not change that much – a pause in September is a tad more likely at close to 90% implied probability, with a hike thereafter still being attached to around a 40% probability.   Fed cuts are priced back in, but the trough is still not materially below 4%   Weak eurozone PMIs but persistent inflation pressures cause ECB headaches Yesterday’s rally, however, began in Europe with the services PMIs coming in a lot weaker than anticipated and falling into contractionary territory. Bunds rallied, pulling USTs alongside, but with the gap widening temporarily to over 170bp in 10Y.   As bleak as the macro outlook that yesterday’s PMIs painted appears, inflationary concerns are not going away. The PMI reports indicated an upturn in service sector input cost inflation, i.e. rising wage pressures. Add to this that the market's long-run inflation expectations have also not come down much – 5y5y forward inflation still stands at a historically elevated 2.6% after dropping 3bp yesterday – and it remains an overall uncomfortable situation for the European Central Bank. The ECB hawks may still be tempted to push through a final hike before it is too late.   As for the ECB pricing, markets now see a greater chance for a pause in September. Ahead of yesterday markets were looking for a slightly greater than 50% chance for a hike, now that stands at 30%. it’s now the overall probability for a hike before year-end that stands at 50%, having been close to fully priced in the days before.     More ECB tightening is seen as less likely Today's events and market view Should one data point be enough to upend the narrative that has driven the rise in US rates and turn the tide? The 20Y UST auction showed overall yield levels were high enough to attract decent demand again, but a good amount of short covering seems to have been at play in yesterday’s reversal as well. When it comes to risk assets, the bad news was good news with equities looking up. In the end, that can also help dampen the bull flattening move.     On the other side, inflation is still residing at elevated levels above the Fed’s target. Despite the more encouraging dynamics of late, it is too early to declare victory. With that in mind, we head into the Jackson Hole symposium with the spotlight on Fed Chair Powell’s speech tomorrow. The general sentiment appears to be for him to stick to the recent Fed script, if anything with a slightly hawkish risk of more pushback against the pricing of rate cuts. Today’s data slate sees the release of the US initial jobless claims and durable goods orders as the main highlights. After yesterday's data, it seems markets will be more sensitive to any signs of weakness. In primary markets, the US Treasury will sell 30Y inflation-linked bonds.      

Yesterday, the pair formed several good signals to enter the market. Let's analyze what happened on the 5-minute chart. In my morning review, I mentioned the level of 1.0870 as a possible entry point. Growth and false breakout of this level generated a sell signal, and the pair fell by more than 60 pips. During the US session, safeguarding the support level at 1.0808 and weak US data produced a buy signal. As a result, EUR/USD managed to compensate for all morning losses and rose by more than 50 pips.   For long positions on EUR/USD: Softer-than-expected preliminary US PMI data exerted downward pressure on the dollar and the euro strengthened in the second half of the day. Obviously, there's a lot of market manipulation, making the situation increasingly tense before the Jackson Hole symposium. Yesterday's data made it clear: if the Federal Reserve continues its tight policy stance, the economic situation will only worsen. This has further confused market participants, who were expecting hawkish statements from Fed Chair Jerome Powell. In the absence of EU reports in the first half of the day, I expect EUR/USD to trade within the channel. Therefore, it is advisable to trade on a dip following a false breakout near the low of 1.0849, which is in line with the bullish moving averages. An immediate resistance target is set at 1.0889, formed on Tuesday.   A breakout and a downward test of this range will strengthen demand for the euro, suggesting a bullish correction around 1.0928. The ultimate target is found at 1.0958, where I will be locking in profits. If EUR/USD declines and bulls are idle at 1.0849, the bear market will persist. Only a false breakout around the next support at 1.0827 will signal to buy the euro. I will initiate long positions immediately on a rebound from the low of 1.0804, aiming for an upward correction of 30-35 pips within the day.   For short positions on EUR/USD: The sellers lost all their advantage yesterday and now they need to start from the beginning. Today, to maintain the bearish momentum, sellers will have to assert their strength at the new resistance of 1.0889. The pair may test this level soon. The absence of economic reports will help the bears with a false breakout of this level and will lead to another descent towards the 1.0849 support. However, only a breakout below this range, followed by an upward retest, will generate another sell signal, paving the way to the low of 1.0827, where I expect big buyers to emerge in hopes of building the lower band of the new ascending channel. The ultimate target is seen at 1.0804, where I will be locking in profits. If EUR/USD moves upward during the European session and lacks bearish activity at 1.0889, the bulls may try to re-enter the market. In such a scenario, I would go short only when the price tests the new resistance at 1.0928 that was formed yesterday. Selling at this point is possible only after a failed consolidation. I will initiate short positions immediately on a rebound from the high of 1.0958, considering a downward correction of 30-35 pips within the day.     COT report: The COT (Commitment of Traders) report for August 15 shows a notable increase in long positions and a drop in short positions. These figures already factor in the crucial US inflation data, which brought back some buyers to the market. The Federal Reserve meeting minutes released last week also indicated that not all committee members are aligned with the idea of raising interest rates to combat inflation. This keeps the chances of the euro's recovery alive, especially following the Jackson Hole symposium happening later this week where Federal Reserve Chairman Jerome Powell is scheduled to speak. His address might shed light on the central bank's future policy direction. It is important to note that the recent decline in the euro seems to be appealing to traders. The optimal medium-term strategy under current conditions remains buying risk assets on a dip. The COT report highlights that non-commercial long positions increased by 4,418 to stand at 232,466, while non-commercial short positions decreased by 5,634 to 72,603. Consequently, the spread between long and short positions surged by 1,125. The closing price was lower, settling at 1.0922 compared to 1.0981 the previous week.     Indicator signals: Moving averages: Trading is taking place around the 30-day and 50-day moving averages, indicating market uncertainty. Please note that the time period and levels of the moving averages are analyzed only for the H1 chart, which differs from the general definition of the classic daily moving averages on the D1 chart. Bollinger Bands If EUR/USD declines, the indicator's lower border near 1.0825 will serve as support.   Description of indicators: • A moving average of a 50-day period determines the current trend by smoothing volatility and noise; marked in yellow on the chart; • A moving average of a 30-day period determines the current trend by smoothing volatility and noise; marked in green on the chart; • MACD Indicator (Moving Average Convergence/Divergence) Fast EMA with a 12-day period; Slow EMA with a 26-day period. SMA with a 9-day period; • Bollinger Bands: 20-day period; • Non-commercial traders are speculators such as individual traders, hedge funds, and large institutions who use the futures market for speculative purposes and meet certain requirements; • Long non-commercial positions represent the total number of long positions opened by non-commercial traders; • Short non-commercial positions represent the total number of short positions opened by non-commercial traders; • The non-commercial net position is the difference between short and long positions of non-commercial traders.    

... as well as in EUR The bear steepening is not confined to the US. In Europe the 10y Bund yield briefly pushed past 2.8% and the 30y hit 3%. Interesting to note is that this happened with longer term inflation expectations actually dropping, so entirely real rate driven. Risk assets of course are not liking it. In European sovereign space this has seen Italian bond spreads over Bunds prolonging their widening leg, taking the 10y spread to 186bp today. But overall widening was a moderate 2bp in relation to the 5bp outright move today, also considering it was largely directional widening since the start of this month. But at the same time that widening over the past week also happened alongside implied rates volatilities coming down, which should normally support spread products. Implied volatility has picked up a tad over the past few sessions but still remain at their lowest since June. In part, it may be the explanation why Bund asset swap spreads (ASW) have remained relatively tight as they mirrored that broader move. That is still notable though, as a lot of the factors traditionally driving the Bund ASW are on the move, and pulling in different directions. Risk sentiment as measured by sovereign spreads has been one factor, but its influence seems muted, with other risk measures like volatility being down. The European Central Bank’s chatter about quantitative tightening has become louder, but the additional effective net supply that a speedier unwinding of the ECB’s bond portfolios implies may take more time to actually realise. More near term, supply could actually still drop, when the German debt agency updates its quarterly funding plan today. And starting next week government deposits currently still sitting on the Bundesbank’s balance sheet will no longer be remunerated and could hence push into the market for high quality collateral.   10Y yields are on long term highs, but the curves still have room   Today's events and market views The data calendar for the US already gets busier with the releases of house price data, new home sales numbers and the Conference Board consumer confidence survey as highlights today. The European data calendar has less on offer but we will see quite a few ECB officials making public appearances, including chief economist Lane and Austria’s Holzmann. Government bond primary markets will stay busier with a 10Y tap out of the Netherlands, a 5Y tap from Germany and Italian short term plus linker auctions. The main highlight will probably be the release of the German fourth quarter funding plan with cuts to the issuance target expected. The UK taps its 10y green Gilt and the US Treasury sell a new 2Y note.

FX Daily: US bond market sets the FX tone The ongoing sell-off in the US bond market continues to set the tone – not just for FX markets but for risk assets in general. A heavy slate of US Treasury auctions this week and rising concern over a US government shutdown on Saturday is sending implied volatility higher and may trigger some more profit-taking on carry trade strategies.   USD: Focus on Treasuries again The dollar continues its grind higher and probably the biggest market talking point is the ongoing bearish steepening of the US Treasury curve. Speaking to our bond strategists, they think this is currently being driven by two factors. The first is the ongoing upward revision to where the Fed Funds rate settles after the next Fed easing cycle. Looking at the forward curve for one-month USD OIS rates, investors now see the low point in any future Fed easing cycle at around 4.00% in three years's time. Rather incredibly, at the start of this year, the market had seen the low point for Fed Funds in three years' time down at 2.70%. The second factor weighing on Treasuries is this week's $134bn auction of two, five and seven-year notes – which takes place over the next three days. This comes ahead of a potential US government shutdown this Saturday, where hard-right Republicans in the House seem to be holding out against a stop-gap spending bill. In the background remains a threat of another downgrade of US sovereign rates on the back of an 'erosion of governance'. Apart from the rise in US yields, we have now started to see a rise in implied volatility in the US Treasury market. This will prove a headwind to carry trade strategies and could prompt the unwinding of some of the most heavily invested positions. We would worry about the Mexican peso here, which also faces Banxico unwinding its dollar forward book in less than benign conditions. Another popular target currency in the carry trade – the Hungarian forint – may actually find some support from the local central bank today (see below).  In general, however, the continued rise in US yields is making for a less benign environment and favours risk reduction. Whilst higher US yields may push USD/JPY close to 150, they also increase the risk of an equity setback. That is why we think an instrument like the one-month USD/JPY downside risk reversal may be too conservatively priced. And in general, we would say commodity currencies remain vulnerable, especially those like the South African rand and Latam currencies – this latter group were hit hard during the early August sell-off in Treasuries. DXY can probably stay bid through this if activity currencies come under pressure and technical analysts will be dusting off calls for a move to the 107.20 area.

FX Daily: EMFX surfs in a sea of green It seems investors are starting to think that the Fed is done with rate hikes and are now starting to reduce underweight positions in risk assets, including emerging market currencies. This is dollar negative. Today's US jobs data will be a key determinate of whether this week's new trend has legs or will be quashed by strong hiring or wage numbers.   USD: Will NFP can feed into the Fed pause narrative? European investors face a sea of green as they survey global equity markets this morning. Decent 1-2% rallies in global equity benchmarks have been seen right through Europe, the US and Asia. Underpinning that move undoubtedly has been the drop in US rates, where investors are shifting away from the higher-for-longer Fed narrative which dominated in September and October. They now seem to be exploring the Fed pause/Fed peak story. For reference, pricing of 1m OIS USD rates in two years' time rose from just above 3% in June to a peak of 4.75% last month and has since dropped back to 4.17%. The move in rates has surely seen investors scale back some paid USD rates/long dollar positions and prompted an unwind of some favourite short currency positions in the EM and commodity space. That is why we think the Australian dollar is doing so well and we continue to see upside for a relative value trade in the region, long AUD/CNH. We also note with interest a big drop in USD/KRW overnight. The Korean won typically has a high beta on global equities (but not an attractive yield) and its sharp rally is a good barometer for the mood in the market. With Korean FX reserves falling for a third month in a row it seems Korean FX authorities have been supplying the market with FX liquidity, as have the likes of China and India – presumably along with Japan shortly too. We think the drop in USD/KRW helps define a broadly risk-on, soft dollar environment today. Whether this environment has further to run will be determined by today's October US jobs data. Despite the ridiculous inverse correlation with ADP (which might point to a +350k NFP number today) consensus is around +170/180k. Investors will also want to see whether last month's +336k figure gets revised lower. Consensus also sees a 0.3% month-on-month average earnings figure, but that should still bring the year-on-year down to 4.0%, the lowest since June 2021. Assuming no upside surprises today, we favour the dollar handing back a little further of its gains, especially against the high yielders (e.g., Mexico and Hungary) given the renewed interest in the carry trade.  DXY could drop to the 105.50/55 area today as long as the US jobs data is not too strong.  

Rates Spark: Enough to hold rates down The US 10yr yield remains below 4%. However that's not been validated by the data as of yet. Friday's payrolls report can be pivotal here, but based off consensus expectations the market will remain without validation from the labour market. Also, the Fed's FOMC minutes due on Wednesday are unlikely to be as racy as Chair Powell was at the press conference.   Sub 4% on the US 10yr to hold at least till we see Friday's payrolls outcome The 13 December FOMC meeting outcome remains a dominating impulse for the rates market. The US 10yr yield shot to below 4% on that day, and has broadly remained below 4% since. It was briefly below 3.8% over the holiday period, but now at closer to 4% it is looking for next big levels. The thing is, validation of the move of the 10yr Treasury yield from 5% down to 4% came from the Fed, but not so much from the macro data. We can reverse engineer this and suspect that the Fed has either seen something, or fears that it will see something that will require lower official rates. In consequence, data watching ahead remains key. In that respect, we are days away from a key reading on the labour market as December’s payrolls report is due on Friday. A consensus outcome showing a 170k increase in jobs, unemployment at 3.8% and wage growth at 3.9% would leave us still lacking validation for lower market rates from the labour market data. We have it from survey evidence, and from scare stories on credit card debt and commercial real estate woes. But it's the labour market that is really pivotal. Risk assets struggled a tad yesterday, and that makes a degree of sense given the complicated back story, and the remarkable rally seen into year end. While a one-day move cannot be simply extrapolated, there are reasons to be a tad concerned on the risk front at this early phase of 2024. Geo-political concerns have not abated, and in fact if anything are elevating. Europe is closest to many of these risks, and the economy has been faltering for at least a half year now. Yes the market is expecting rescue rate cuts, but the European Central Bank is yet to endorse those expectations. An elevation of stress without the prospect of near term delivery of rate cuts can be an issue for risk assets. For market rates, this combination maintains downward pressure. The only issue is how far we’ve come so fast. We remain of the view that the US 10yr fair value level is around 4%, but that we will likely overshoot to the downside to 3.5% in the coming months. Our fair value comes of a forward 3% floor for the funds rate plus a 100bp curve. See more on that here.   Today's events and market views It's quiet in Europe for data through Wednesday. The bigger focus for Europe will be on regional inflation readings for December due on Thursday, along with a series of December PMI readings. The likelihood is for some stalling on inflation reduction alongside confirmation of ongoing manufacturing and business weakness. In the US on Wednesday we get ISM readings that will also show a degree of pessimism in US manufacturing. The job openings data will also be gleaned, but the bigger market impulse can come from the FOMC minutes, ones that will refer back to the pivotal 13 December meeting. The odds are they won’t be nearly as dovish as Chair Powell was at the press conference.

The Commodities Feed: Energy starts 2024 on a softer note Energy markets started the new year weaker with both oil and gas prices coming under pressure yesterday. This is despite growing tensions in the Middle East.   Energy – Oil starts the year weaker The oil market started the first trading day of 2024 on a softer note with ICE Brent settling almost 1.5% lower yesterday. Energy markets were unable to escape the broader pressure seen on risk assets with equity markets also weaker. The weakness in oil comes despite a ratcheting up in tensions in the Middle East. Iran has sent a warship to the Red Sea after the US sunk several Houthi boats in the region, following a number of attacks on commercial ships by the Houthis. While the geopolitical situation is a concern for the oil market, a fairly comfortable oil balance over the first half of 2024 does help to ease some of these worries. OPEC+ will hold a Joint Ministerial Monitoring Committee meeting in early February, according to Bloomberg. The group will be keen to discuss the state of the oil market, particularly given the price action seen following the announcement of deeper cuts last month from a handful of members. However, given the scale of cuts we are already seeing, it will be increasingly difficult for the group to cut more if needed over the course of 2024. Already, the last few rounds of cuts have been driven by voluntary reductions from individual members rather than group wide cuts – a sign that it is becoming more difficult to get all members on board to cut. European gas prices have come under significant pressure, with TTF settling 5.5% lower yesterday and at its lowest levels since August. This weakness comes despite forecasts for colder weather later in the week. However, storage remains very comfortable with it a little more than 86% full, which is above the 83.5% seen at the same stage last year. In the absence of any supply shocks or demand surge, it is looking likely that European storage will finish the 2023/24 heating season around 50% full, which suggests limited upside for prices.

FX Daily: Not too hot to handle Rate expectations were not moved by slightly hotter-than-expected US CPI, and support for the dollar has mostly come through the risk-sentiment channel. Range-bound trading may persist despite conditions for a stronger dollar. Inflation in the CEE region is falling; the NBR leaves rates unchanged.   USD: Markets still attached to March cut US CPI data came in a bit hotter than expected yesterday, with the core rate rising 0.3% MoM and slowing to 3.9% YoY versus 3.8% consensus. The upside surprise in headline inflation was bigger: an acceleration from 3.1% to 3.4% YoY versus the 3.2% consensus. The dollar jumped after the release, also thanks to weekly jobless claims printing lower than expected. Somewhat surprisingly, the US yield curve did not react by scaling back rate cut expectations, as a knee-jerk selloff in 2-year Treasuries was fully unwound within an hour of the CPI release. We've already discussed how we did not expect this inflation read to leave a long-lasting impact on markets, and it definitely appears that most of the fixed-income investor community is almost overlooking the release. The support to the dollar appears mostly tied to the negative response in equities, given the neutral impact on short-dated US yields. A March rate cut is still over 60% priced in, and we still see short-term vulnerability for risk assets from a hawkish repricing. The conditions for a higher dollar this month are surely there, but we have observed numerous indications that markets remain reluctant to make short-term USD bullish positions coexist with the longer-lasting view that US rates will take the dollar structurally lower by year-end. The chances of rangebound trading until we receive clearer messages by activity data and the Fed are high. Today, PPI figures for December will be released, adding information about lingering price pressures and potentially steering the market a bit more. On the Fed front, we’ll hear from hawk Neel Kashakari.

Nearly all of the major ones ended the week within 0.5% of where they had started, an unusual level of quiescence. The hotter-than-expected consumer inflation report out of the US initially made some waves, and helped the dollar rally modestly. By the end of the week, markets were, however, back assigning an implied 80% chance of a March cut in Federal Reserve rates after a miss in Friday’s producer inflation report. Government bond yields were lower and risk assets rose upwards in response, while the dollar was essentially flat. This week is relatively quiet in terms of economic data or policy announcements, although there will be an unusual number of ECB and Federal Reserve speeches on tap. The November Eurozone industrial production data on Monday, and December UK inflation on Wednesday, provide the main economic references. Federal Reserve speeches will be particularly critical to see if the central bank continues to push back against market hopes for a March cut in rates and 165 basis points of cuts for the whole of 2024, which still strikes us as way too aggressive.  

The Australian dollar has struggled so far this year, as receding bets in favour of Fed rate cuts hammer risk assets, while economic data suggests that the Australian economy contracted at the end of 2023. Last week’s preliminary PMI data for December was a disappointment. The composite index edged upwards in the final month of the year, although fell short of expectations and continued to print well below the level of 50 for the third straight month (46.9). Quarterly GDP data won’t be released until early-March, although it would be reasonable to assume that a QoQ contraction in activity is a distinct possibility. Investor expectations regarding the state of the Australian economy will be key in determining the extent of any continued rebound in AUD in the coming weeks. This week will be a relatively busy one in that regard, with housing, retail sales and trade data to be released on Tuesday and Thursday. Arguably the most important data point will, however, be Wednesday’s monthly inflation print for November. Any downside surprise here could further weigh on AUD this week

Rates Spark: Near-term balance of risks still tilted towards higher rates Markets are geared for dovish outcomes this week, not just in rates where still notable probabilities are discounted for first cuts as early as March, but also across wider risk markets. This sets up markets for disppointments if they don't get exactly what they want. Data is a wild card, but the ECB will have this in mind if it is earnest about pushback.   Near-term balance of risks still tilted towards higher rates The thought of a soft landing actually materialising against all odds are supporting risk assets in all corners of the market. The S&P 500 closed at new record levels on Friday and also on Monday the equities rally pushed on through. In rates the pricing in of a soft landing has pushed down rates along the curve at the start of the week, supported by the idea that inflation is coming down as markets are eyeing this week’s PCE data. But markets are starting to fine-tune their expectations more in line with our thinking, even if we see more scope for correction in this direction: pricing for a March Fed cut is now down to 10bp, even though overall pricing for cuts this year has even deepened somewhat again to 134bp. Even though we also see inflation coming down steadily, we warrant caution about markets still getting ahead of themselves – especially in EUR rates. The European Central Bank will meet on Thursday and we expect a reiteration of their data-dependent path towards policy normalisation. Last week yields came down the day that Lagarde hinted at rate cuts in the summer. The best that markets can hope for is a reiteration of that comment, but given the guarded fashion of Lagarde’s statements we can see a scenario where she does not repeat this dovish message in the context of the policy meeting this week. We therefore see a chance that EUR 2Y rates will recalibrate higher again in response to the press conference when markets don’t get exactly what they are looking for. In the US there is also no guarantee that the nudge lower in rates we saw at the start of this week will extend. Markets have their eyes on a 2.0% core PCE inflation, in line with the Fed’s mandate that will be published on Thursday, which, if met, would keep the market pricing of a March rate cut as a realistic scenario. If, on the other hand, the actual number were to exceed 2.0%, even by a bit, we could imagine the market reacting more sensitively to such a disappointment. Similarly, we would expect an asymmetric reaction to the GDP growth figures, which our economist expects to come in firm on Thursday. On balance, if data come in as expected the further downside is moderate, but at least near term the potential could still be larger.   Tuesday's events and market views Japan will kick-off this week's central bank meetings but no change of the policy rate is expected. In terms of economic data releases Tuesday will be another light day. The EU Commission will publish the consumer confidence index and the ECB will release results of its bank lending survey. In the US we a few business indicators from regional Feds. It is the rest of the week will be of more interest, with eurozone PMIs on Wednesday, the ECB meeting and US GDP data on Thursday followed by the PCE on Friday. In primary markets Germany will sell 4Y and 30Y green bonds while the Netherlands taps a 15Y bond. The US Treasury sells new 2Y notes. In SSAs the EU has mandated syndicated taps of existing 7Y and 30Y bonds, which should also be Tuesday’s business.