US equities fell prey to profit taking ahead of the start of the earnings season. The S&P shed 0.7%, the NASDAQ 1.35%. Asian equities are trading negatively, but losses are mostly in line with US ones.
Alcoa kicked the US earnings season off with higher‐than‐expected sales and profits. It rose 1% in late trading.
Fed governor Kocherlakota, a dove, signalled that Fed interest rate increase lays well into the future, as he sees inflation below 2% in a one‐to‐two year outlook and inflation averaging below 2% over the next four years. Labour markets have improved, but the pace of improvement was disappointing. Rates will be low relative to the past for more than a few years.
Fed Lacker, a hawk, has lowered his growth expectations following past forecasts disappointments. He didn’t talk the much stronger June payrolls up and sees only a moderate improvement in housing. He also thinks that the Fed should raise rates in 2015, as the majority of governors do. Quite moderate talk from a hawk.
Chinese CPI edged down a little bit more than expected to 2.3% Y/Y in June from 2.5% Y/Y previously. The decline was driven by lower food prices. Core CPI was unchanged at 1.7% Y/Y. Prices are expected to remain subdued in the months ahead.
Today, the eco calendar is nearly empty. Attention will go to the ECB speakers and the Minutes of the FOMC meeting. Auctions are held in Germany and the US.
Markets
Bund sets new highs; 10-yr yield at 1.21% eyeing alltime lows
Yesterday, core bonds had another constructive session. The Bund set a new contract high and the 10‐year yield set a new cycle low (1.218%), but also the US Treasuries eked out nice gains. The curves flattened. It was really a risk‐off session, as evidenced also by the decline of equities and the rise of the yen. Volumes traded were better than in previous days, but about average. It was a slow, but steady advance throughout both the European and US sessions. In the European session, the rally was more driven by weak eco data and dovish ECB talk. In this regard, ECB Linde was the first ECB governor to explicitly mentioning deflation risks. US eco data were mixed: strong JOLT labour data and weak small business sentiment (NIFB). The US 3‐year Note auction was okay despite a mixed buy‐side participation. US yields were up to 6.4 bps lower, while German ones up to 3.7 bps. The 10‐year US‐German yield spread narrowed to 134 bps. Peripheral bonds were on the defensive (risk off) and 10‐year yield spreads widened to up to 13 bps (Greece was hit also for country‐specific reasons, see Sunset).
USD fighting an uphill battle as core bond yields weigh
Yesterday, the risk‐off sentiment dominated European equities. It weighed on USD/JPY, as core bond yields drifted further south. The spread between US and core European bonds even narrowed a touch. The decline of the dollar against the euro was limited, but EUR/USD finally returned well north of 1.36. USD/JPY dropped to 101.50 area. Even so, the damage in USD/JPY could have been worse, too. EUR/USD and USD/JPY trade with a slight USD negative bias but are still locked in very narrow ranges.
Sterling bulls were wrong‐footed by a surprise decline in UK production yesterday. Sterling spiked lower against the euro and the dollar after the publication of the UK but at the end of the day, the losses of sterling, if any, were very limited. EUR/GBP closed the session at 0.7948, from 0.7945. Cable ‘profited’ from overall USD weakness and closed at 1.7131 (from 1.7128). The currency markets apparently see yesterday’s disappointing UK data as a one‐off.
Today, attention for ECB talk and FOMC Minutes
Today, the eco calendar is devoid of market moving items. However, the event calendar is rich. It contains speeches of ECB members Coeure, Praet, and president Mario Draghi, besides the release of the June 17‐18 FOMC Minutes. Germany taps its 0.25% 2016 Schatz and the US Treasury re‐opens its 10‐year benchmark.
ECB speakers should always be listened to for subtle shifts in their thinking. However, the July meeting has passed only recently and thus especially the members of the executive board should stick to “battle plan” that was laid down by president Draghi. The ECB wants to buy time and will wait for results of the June measures before deciding whether they need to do more. It is however unlikely that the market will back off anytime soon. The recent eco data suggests a slowing of the momentum from already a very tepid pace and the inflation data show no signs of an acceleration of the price increases. The euro is as firm as it was before the June meeting. ECB Linde, the BOS president and not member of the executive board, broke the “omerta” and spoke about deflation risks. So, we are on heightened alert when the ECB members speak, but the basis hypothesis is that they won’t change their intentions of buying time for now.
The FOMC Minutes will be scrutinized closely for hints on the latest evolvements of thinking inside the Committee. However, the FOMC statement following the meeting didn’t contain surprises and Ms. Yellen in the press conference did her utmost best to keep a tightening of policy out of the mind of markets. She dismissed also recent higher inflation readings as “noisy”. Ms. Yellen also said that discussions on operational procedures it will implement when it raises interest rates and on other aspects of the exit policy are ongoing. So, that might be the focal point for analysts. The effect on markets should be minor though.
Bond trading: Attraction to 1.12% low irresistible?
Asian trading gives us little clues. Risk‐off still dominates, but maybe only catching up on the US. Treasuries trade unchanged, as is the dollar. No market moving eco data, but three ECB governors speak. Our basis assumption is that they stick to their message of buying time. The Schatz auction is a bit of a wild card. Sentiment is of course bullish, but the Schatz trades at less than 2 basis points, the lowest in more than one year. However, the June Schatz auction went well (average yield 6 bps) with 1.9 bid/cover and lower Bundesbank retention and a 2 cents tail. Whatever, it shouldn’t impact the secondary market trading much. The Bund reached a new contract high and the 10‐year yield dropped to 1.21%, a cyclical low. So, the technical picture remains bullish. It looks that the attraction of the 1.12% all‐time low (10‐year yield) will become irresistible. The environment of weaker eco data, low inflation will keep the hope on QE alive. The spread widening between US and German bonds shows that the decoupling protects the German bonds for a sell‐off in Treasuries should the signal come that Fed tightening is becoming more concrete. Such a prospect is though unlikely in the near term with the Yellen testimony on July 15 a wild card. In this context we cannot be negative of Bunds, even if we think Bunds are too expensive and the distance with the all‐time lows too small to set up additional long positions. For today, we have no strong bias.
EUR/USD today: Sell on upticks?
This morning, most Asian equities trade with moderate losses. The Chinese price data were fairly constructive (see headlines). The data confirm the stabilization scenario of the Chinese economy. The impact on USD/JPY or EUR/USD is limited. The risk‐off sentiment continues to weigh on the dollar. EUR/USD is changing hands in the 1.3615/20 area. USD/JPY is rather resilient to the overall risk‐off modus and trades in the 101.50/60 area.
Later today, there are again few eco data with market moving potential in the US or in Europe. The focus will be on the communication from central bankers with several ECB members (including president Draghi) speaking (see above). Later today, the FOMC minutes will draw some attention too. We don’t expect the ECB or the Fed to amend their dovish communication. So, trading in EUR/USD and USD/JPY will still be driven by the global risk‐off sentiment.
Yesterday’s price action illustrates that the dollar is vulnerable in this context. At the same time, EUR/USD doesn’t look like preparing a rebound beyond any technically relevant level. The short‐term picture FOR EUR/USD is perfectly neutral. The topside is rather well protected in the 1.3700/34 area, but this still doesn’t mean that one should expected a big move lower today. Even so, a sell‐on‐upticks bias within the 1.3700/1.3503 short term trading range is still slightly preferred. USD/JPY is drifting lower within the established trading range, but for now it doesn’t look that the key 100.75 area will be broken anytime soon.
Sterling Today: Consolidation in EUR/GBP?
This morning, BRC shop prices dropped further from ‐1.4%% Y/Y to ‐1.8% Y/Y. There is no reaction on the major sterling cross rates. EUR/GBP is changing hands just below 0.7950. Cable is holding stable in the 1.7130 area. At the start of the European trading session, the Halifax House prices will be published. The importance of housing data for monetary policy is becoming a bit less important as the BoE tries to use macro‐prudential measures rather than global monetary policy. So, a big surprise is needed for this report to have an impact on sterling. Over the previous two days, sterling gave some conflicting signals. On Monday, the UK currency looked ready for a (limited?) correction, but sterling was quite resilient despite poor UK production data yesterday.
In a broader perspective, Cable is holding remarkably strong supported by overall dollar weakness, but the 1.7175/80 area is a strong resistance. We assume that a new up‐leg will be difficult. EUR/GBP is still within reach of the cycle low reached, but the pair is moving into oversold territory and is nearing the bottom of the established downtrend channel. The downtrend remains in place, but in a short‐term perspective the sterling rally against the euro needs some further consolidation.
This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.
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