ECB’s Lagarde caves and hints at a July rate hike

Markets

US headline/core inflation for April came in at 8.3%/6.2% yesterday, defying expectations for a bigger decline from the 40‐year highs. Core inflation also showed more signs of broadening and being increasingly persistent. It wasn’t the surprise reading both markets and the Fed hoped for, fueling concerns of an aggressive tightening cycle that may smother the economy. US stocks initially clung on to the fact inflation fell nevertheless but that proved a tooweak argument in a sell‐on‐upticks market. The Nasdaq again underperformed (‐3.18%). US bond yields soared up to 12 bps shortly after the CPI release only to end up with +2.6 bps at the front. Yields on longer tenors even turned red, losing almost 8 bps at the very long end. The 10y lost the 3% mark. European/German yields initially joined the US move higher but here too things soon went in reverse. German Bund yields fell as much as 3.1 bps, European swap yields printed losses of more than double. This happened even as ECB’s Lagarde finally caved and hinted at a July rate hike. In this respect, EUR/USD’s performance was disappointing. Overall risk‐off even pushed the pair marginally lower to 1.0512. The trade‐weighted dollar index keeps knocking on the 104 door. Sterling was long an ocean of calm yesterday but came under pressure around the time US stocks started sliding. EUR/GBP rose from 0.855 to 0.858. GPB/USD closed at 1.225, the weakest level since May 2020.

Asian stocks lose 1‐3% this morning on lingering inflation worries. Market news is limited. US bond yields extend their recent correction with 1.2 to 4.4 bps. Hong Kong intervened in its currency (see below). The Japanese yen outperforms. USD/JPY eases sub 130. EUR/USD is filling bids in the low 1.05 area.

US PPI and jobless claims on today’s eco calendar are worth mentioning but we don’t expect them to influence markets. Yesterday’s moves on core bond markets suggest we may have entered a period of consolidation, correction perhaps, where growth worries take over from the tightening/inflation narrative. First support in the US 10y is situated at 2.83% but the crucial one is located around 2.72%. Germany’s 10y is losing the 1% support with the next reference around 0.80% (2018 top). If uncertainty about the eco outlook indeed becomes the dominant theme, it’ll be difficult for EUR/USD to escape the gravitational pull from 1.05. Sterling extends yesterday’s losses after Q1 GDP growth came in lower than expected at 0.8% q/q while the cost‐of‐living crisis suggests no improvement for the coming quarters. UK Finance minister Sunak is said to provide more relief in August but that may be too little too late. EUR/GBP surpasses 0.86 resistance (Nov/Dec 2021 correction highs).

News headlines

The Hong Kong Monetary Authority (HKMA) intervened in the currency market to prevent the HK dollar from weakening beyond the allowed USD/HKD 7.75 to 7.85 trading band. The HKMA bought HKD 1.586 bln. The peg of the Hong Kong dollar with the US dollar is under pressure due to rising US yields/interest differential between US and Hong Kong money market rates. Interventions aim to drain liquidity from the local market to raise local money market rates. It was the first time since early 2019 that HKMA had to intervene in the currency market to support the local currency. In October 2020 it last intervened to prevent the HKD from strengthening outside the allowed bond. USD/HKD still trades near 7.85.

According to the a report in the Financial times, Turkish authorities are raising pressure on local bank to limit corporate clients from buying foreign currency against the Turkish lira in order to prevent a further weakening of the local currency. According to the article, banks have to seek approval from the central bank for bigger amounts of FX purchases. Since the start of the year, the Turkish lira has traded relatively stable even as combination of elevated inflation (69.97% Y/Y in April) and a low policy rate (14%) leave the currency with a deeply negative real interest rate. However, over the previous days, the lira again showed tentative signs of weakening with EUR/TRY rising to 16.23, compared to levels around EUR/TRY 15.53 end last month.

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