The reversal in core bonds that started late on Tuesday continued yesterday. Just as there was no specific reason for the huge risk-off early this week, there was no major trigger for the moves yesterday. Some refer to better-than-expected earnings easing some of the growth fears. While it may have helped, it was probably also technical with the short squeeze/capitulation move by bond shorters perhaps coming to an end. US yields recouped 5.1 bps (5y) to 6.7 bps (10y, still sub 1.30%) with both inflation expectations and real yields rebounding. German Bunds outperformed. Yields rose 1.5 bps (10y) to 3 bps (30y). Equity sentiment also vastly improved. European stocks eked out a nice 1.78% gain (EuroStoxx50 back above 4k). Wall Street rose a little less than 1%. The dollar (and even more the Japanese yen) weakened. EUR/USD reversed earlier losses to finish higher from 1.1781 to 1.1794. Currencies that were under pressure at the start of the week, rebounded. That includes sterling which strengthened from EUR/GBP 0.8645 to just south of 0.86. The optimistic tone holds into Asian dealings where stocks are trading in positive territory everywhere in a session with little economic news. Hong Kong and India outperform. Japan is closed for the remainder of the week. Core bond futures trade a little higher after yesterday’s blow but are off highs. FX markets trade muted. The dollar is showing no clear direction.
The ECB meets today. The July reunion gained in importance after the unexpected conclusion of the strategy review. The inflation target changed to a hard 2% with over- and undershoots equally undesirable and allowed only temporarily. Hitting the new target will probably take a bit longer, thus strengthening the case for prolonged easy monetary policy. Lagarde said guidance in the statement will reflect the polished policy goals. What will be interesting however, is to what extent the new guidance/target will impact the current ECB programmes, including PEPP. The ECB President hinted at a transition of PEPP into a “new format” after its formal deadline in March 2022. By doing so, she prevents markets from anticipating an abrupt end that could cause rates to spike. It is not sure though that Lagarde will go into much details already today. Developments in PEPP, also regarding the buying pace, are usually being discussed when new staff projections are at hand. The next such meeting is in September. We’re also very curious about the ECB’s view on the July core bond surge. Yields have fallen so deep it might even make the ECB uncomfortable. The overall message in any case is likely going to be a dovish one. Question is how much is priced in already, especially given the recent declines not only in yields but also in the euro. That said, the downside alert is still here with us, even with yesterday’s reversal. For that to be called off, the German 10y yield should take out resistance around -0.34/35% first and -0.30% next. In EUR/USD we’re looking at 1.1836.
The post-Brexit rift between the UK and the EU on the Northern Ireland Protocol continues. The UK called the EU consider a meaningful rewriting of the agreement. The UK proposals aim to reduce the controls on trade between the Britain and Northern Ireland which remained part of the EU customs union. Amongst other topics, the plan includes a system that goods labelled ‘for NI’ wouldn’t face customs checks. The UK also wants the role of the European Court of Justice in enforcing the protocol to be revised and a change Article 10 on state aid that could affect goods trade in Northern Ireland. European Commission Vice President Sefcovi already rejected the idea of a renegotiation and wants any amendment to take place within the established framework. The UK’s Brexit Minister Frost in Parliament again raised the option that the UK could unilaterally deviate from parts of the agreement. For now, the new phase in the post-Brexit sage had limited impact on sterling. In line with a broader improvement in sentiment, the UK currency yesterday rebounded with EUR/GBP returning from the 0.8650 area to close near 0.86.
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