European interest rate markets: There is no indication that the uptrend will be reversed

Markets

(European) equity markets were captured in an outright risk-off mode yesterday, building on recent fear for destabilizing effects of an inflation uptick. European indices lost 1.50%/2.0%. The sell-off initially coincided with a further rise in yields, with both the German 10-y yield and the 10-y swap rate touching new cycle peaks respectively at -0.07% and 0.21%. Later, financial measures of inflation expectations (and commodities) gradually eased, slowing the rise in yields. The ECB warning on financial stability risks added to the idea that the debate on reducing the pace of emergency asset purchases probably will remain alive already at the upcoming policy meeting. A rise in real yields compensated for the setback in inflation expectations. At the end of the day, the German yield curve slightly bulls flattened with yields declining between -0.1bp (5-y) to 1.7 bp. Still, the uptrend (in yields) remains intact, despite the risk-off. US equities also opened with substantial losses but started a gradual intraday rebound to close with modest losses. The Minutes of the April Fed meeting showed that ‘A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in the upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases. The headlines of the minutes reinforced the intraday trends of higher real yields and easing inflation expectations. Contrary to Europe this combination triggered a further rise in the US yields with the belly of the curve underperforming(5-yup 3.9 bp, 10-y +3.4 bp, 30-y + 0.9 bp). The 10-y real yield jumped 9 bp! The dollar initially profited only very modestly from the risk-off, but the jump in real US yields post-minutes finally helped the US currency to leave recent lows. EUR/USD closed at 1.2175. DXY index returned north of 90.00 (close to 90.19). EUR/GBP rose modestly (close 0.8625).

This morning, Asian equities show a mixed picture with Japan slightly outperforming. Japanese exports rose a stronger than expected 38% Y/Y. Imports also rose more than expected (12.8%), suggesting improving international conditions. The dollar struggles to extend yesterday’s rebound (DXY 90.13, EUR/USD 1.2180).

The eco calendar is thin today with the US jobless claims (expected to decline to 450k) and the Philly Fed business outlook probably only of intraday significance. On core bond markets, we’ll look out how yesterday’s balancing act between a rebound in real yields and softening inflation expectations will develop. At least for European interest rate markets, there is no indication that the uptrend will be reversed as markets look forward to the ECB June 10 meeting. Yesterday’s rise in US real yields bought the dollar some time, but we’re not convinced this will mark the start of a protracted USD comeback. On the euro-side, the catching-up narrative apparently also still works in the background. The 1.2245 resistance area remains within reach. A decline below 1.2050 would call an end to the EUR/USD upside momentum. This still looks quite far away.

News Headlines

Australian employment fell unexpectedly by 30.6k in April (+20k forecast). Details were slightly more encouraging as full-time jobs rose by 33.8k while part-time employment fell by 64.4k. Seasonal effects explain part of the disappointment with easter and school holidays. The Australian Bureau of Statistics suggested that the impact from the expiry of the temporary wage-subsidy stimulus was minimal. The unemployment rate fell from 5.7% to 5.5%, but probably for the wrong reason with the participation rate declining from 66.3% to 66%. Another data released showed Australian consumer inflation expectations rising from 3.2% to 3.5% in May. AUD/USD brushed off the data, trading near AUD/USD 0.7750.

US Secretary of State Blinken released a statement on Russian Nord Stream 2 gas pipeline after meeting with Russian FM Lavrov. Although a US State Department report concluded that the project is a sanctionable activity, the US administration decided to forego on such action. It demonstrates the government’s commitment to energy security in Europe, consistent with President Biden’s pledge to rebuild relationships with US allies and partners in Europe.

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