Focus shifts to the Fed today
Markets
Yesterday’s quite European trading session was interrupted by German parliament. Lawmakers unexpectedly and narrowly turned down CDU-leader Merz’s first bid to get the Chancellor nomination (310 votes). On second attempt, he received 325 votes in the Bundestag, exceeding the 316 necessary in the 630-seat parliament. The episode nevertheless highlights the fragility of the new ruling coalition between CDU/CSU and SPD (328 seats combined). German equities dipped by 2% intraday, but recovered most of these losses by the closing bell. The impact on German Bunds was negligible. The German yield curve bear steepened in the end with yields up to 3.1 bps higher at the very long end of the curve. Fiscal initiatives by the new government are expected by summer. US Treasuries recovered somewhat from the past days’ losses with yields falling by 3.7 bps (30-yr) to 5 bps (2-yr). Strong demand at the US Treasury’s $42bn 10-yr Note sale provided some support. EUR/USD was rangebound between 1.13-1.14.
Chinese markets give a lukewarm welcome to PBOC easing measures this morning (see News & Views). The confirmation of a first high level meeting between US and Chinese officials in Geneva this weekend equally fails to really lift spirits. Talks between Treasury Secretary Bessent and Chinese vice premier He Lifeng mostly serve to de-escalate the situation rather than really start discussions future trade relations. Underperformance at the very long end of the Japanese yield curve (30-yr +8.5 bps; about to set YTD high) is something to monitor with the US note future and especially the German Bund also showing signs of weakness. Focus shifts to the Fed today. The US central bank is expected to keep rates steady and signal no intent to break the deadlock any time soon. The trade-off between downside risks to the maximum employment goal and upside risks to price stability clearly tilt to the latter. Not only because of the expected impact from tariffs on already above target inflation, but also from the self-fulfilling risk coming from surging inflation expectations for consumers and companies. We stick to the view that the Fed rate cut pause will last at least over summer. The Powell Fed has a track record of wanting to be very sure and then going fast. If the labour market breaks, they’ll be inclined to use the ample policy room towards neutral levels as soon as possible. They showcased that last September by kicking off with a 50 bps rate cut. That contrasts hugely with the US money market view of pre-emptive 25 bps rate cuts. A hawkish Fed could hurt risk sentiment and weigh on US Treasuries. EUR/USD 1.1276/74 could be tested again. The Czech National Bank’s policy meeting is a wildcard (cut discounted, pause possible) as it could be indicative on central bank’s reaction functions given the uncertain growth/inflation outlook.
News and views
Asian currencies are on a tear these last couple of days. The likes of Malaysian ringgit, the Taiwanese dollar and the Hong Kong dollar all printed several percentage points gains against their US counterparts. The common factor underpinning the recent surge is rising hope of trade deals, both between the US and Asian economic heavyweight China as well as between the US and several other regional countries. That in turn happened in the wake of several (constructive) trade reports by end last week, including ones that suggest the US-Sino relationship is thawing. The Taiwanese dollar in particular was supercharged by speculation fueled by local press that the government would allow the currency to appreciate as part of trade talks with the US. At some point it strengthened almost 9% over four days. Monetary authorities in Hong Kong have been forced to step in the FX market to protect the currency peg. The HK dollar rose to the strong end of the USD/HKD 7.75-7.85 trading band, prompting already four USD sale operations since Friday which triggered the biggest short-term interest rate drop since 2008.
After enjoying the May 1 – May 5 holidays, China’s onshore yuan also traded significantly stronger on yesterday’s first trading session of the month. That followed the trend set by the offshore CNH, which did trade during CNY’s absence. By setting the daily CNY fixing still above the symbolical 7.20 rate, however, China’s central bank (PBOC) signals it does not want its currency to strengthen an awful lot since a weak(er) currency acts as a shock absorber in the still-ongoing trade conflict with the US. With this in mind, the PBOC today also reduced its main policy rate (seven-day repo rate) to 1.4% from 1.5% and trimmed the reserve requirement ratio by 0.5 ppts. Lowering borrowing costs and releasing liquidity were just a few of the measures announced by governor Pan in a bid to support the economy. USD/CNY recouped some of yesterday’s losses as a result, rising to 7.226 this morning.
Author
KBC Market Research Desk
KBC Bank
