The violent sell-off at the front end of core bond yield curve still resonates

Markets

The violent sell-off at the front end of core bond yield curve still resonates. UK BoE governor pulled the trigger by underlining readiness to act on inflation, causing an underperformance of UK Gilts. UK money markets now take a 15 bps rate hike in November for granted with risks tilted to an even more aggressive move. The BoE is frontrunner among G4 central banks in the battle against persistent price pressures and cut the long-assumed time lag between ending net asset purchases and a first rate hike. UK Gilt purchases still run until the end of the year. The realization that this time lag is no longer a given, prompted hawkish repositioning across the aisle with US money markets now taking into account a total of 50 bps rate hikes in 2022 and EU money markets nearly 20 bps by the ECB. The latter is significant given that the ECB still walks the transitory inflation talk with no strong indication whatsoever on ending net asset purchases, let alone on starting a tightening cycle.

The market reaction at the front end of the curve was the obvious one, but it remains striking that it occurs in a flattening context. Daily changes on the German curve ranged between +5.6 bps (2-yr) and -4.4 bps (30-yr). Yields at 15y+ tenors fell despite the inflation risk and scaled up rate hike bets. One possible explanation is that it might have a lasting (negative) effect on growth assuming inflation doesn’t spiral out of control. A second explanation could be that net asset purchases will remain longer with us than currently assumed and become a permanent feature of future monetary policy. A final explanation could be that any tightening cycle will be short and powerful with central banks afterwards turning their focus again on supporting the economy once supply side shocks leave the system. In any case, for now it feels unnatural that long term bond yields don’t join the move higher. Daily changes on the US yield curve varied between -0.8 bps (30-yr) and +4.4 bps (5-yr). The UK Gilt curve bear flattened with yield changes ranging between +13.6 bps (2-yr) and -0.5 bps (30-yr).

Heavy trading on FI markets marked a stark contrast with subdued action on FX markets. The single currency gained the upper hand over the US dollar and sterling, perhaps as markets ponder the euro’s underdog role. The BoE and Fed already embraced the normalization swing. Whatever the reason, the euro holds the positive vibe in this morning’s positive risk sentiment. Recapturing EUR/USD 1.1664 would be a first sign of bottoming out in the pair. EUR/GBP tries to regain the bottom of the long-standing 0.8450 trading range, only lost last Friday. Today’s eco calendar is empty apart from US housing data. Central bank speakers remain a wildcard for trading. We pay special attention to ECB members.

News headlines

Czech Senate leader Vystrcil suggests that President Zeman is too ill to carry out his duties. Parliament could activate article 66 of the constitution which allows a transfer of powers to other officials. The function to appoint the new prime minister-designate would that way go the speaker of the Lower House. The group of parties that intend to replace the government headed by current PM Babis has claimed that post which would give the initiative to start the formation of a new government. The Lower House holds its first post-election meeting on November 8.

EU competition commissioner Vestager indicated in an FT article that the EU is seeking to extend its relaxation of state aid rules that was introduced to help the economy cope with the pandemic beyond the end of this year. Vestager said: “We want to present what we are doing with hopefully the last version of the temporary state aid framework,” There will be “tools that will help the recovery in these sectors that are still struggling”. She added that future aid will target industries that are hard hit by the pandemic such as airlines and hospitality. Citing unidentified people with knowledge of the plans, the FT indicated that the extension could last until spring 2022.

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