Weak PMIs sent EUR/USD and yields lower

Market movers today

Today's key release is German Ifo expectations due out at 10:00 CEST. Ifo expectations will shed light over what to think about the current and expected future economic situation in the biggest country in the euro area.

In the US, the final University of Michigan survey should attract attention if there are revisions to especially long-term inflation expectations, which jumped to 3.3% from 3.0% in the preliminary report. The print was a major reason why the Federal Reserve increased the hiking pace from 50bp to 75bp.

Besides that there are some central bank speeches during the day, although we doubt we get any new important signals.

The 60 second overview

50bp rate hike from Norges Bank: Yesterday, Norges Bank unanimously decided to raise policy rates by 50bp, against our expectation (and consensus among analysts), taking the sight deposit rate to 1.25%. Markets were pricing in a roughly 50% probability of a 50bp rate hike. The rate path was also quite hawkish. Ultimately, we do not expect Norges Bank to deliver on its new rate path. We think the economic forecasts will prove far too optimistic and we think Norges Bank will deliver much less tightening than signalled. We expect the peak in policy rates to be reached already at 2.25% in December this year. We think the risk of a policy mistake from Norges Bank has risen substantially, which in turn skews both the outcome space and the left tail for Norwegian assets.

Weak PMIs: Both euro area PMI manufacturing and services declined in June although both remain above 50. The PMI manufacturing output sub-component is below 50 (contractionary territory) for the second month in a row. Seemingly a combination of tighter financial conditions, China lockdowns, high inflation (and hence negative real growth) and a high degree of pessimism/uncertainty is weighing on euro area activity growth. That said, the release is broadly in line with the euro area growing around 0.2% q/q. US PMIs also disappointed with declines in both manufacturing and services. The combination of weaker PMIs (including declines in input prices), lower commodity prices and lower inflation expectations have sent yields lower, as investors scale back rate hike expectations. Nearly a full 25bp Fed rate hike has been priced out this year since the Fed meeting. We expect, however, that the Fed needs to step hard on the brakes in order to get inflation under control, although recession risks are on the rise.

Gas: Germany raised it gas risk level to the second-highest 'alarm' phase yesterday, in response to Russia's ongoing gas supply cuts that is putting sufficient gas storage levels for the winter at risk. The heightened alert tightens monitoring of the market and some coal-fired power plants will be reactivated, but the government refrained from enacting measures that would allow energy companies to pass on cost increases to consumers and businesses much more quickly for now. Natural gas futures prices are up more than 50% over the last two weeks and leading German politicians have become more vocal recently with their warnings about rising recession risks and a possible collapse in energy markets. While only level 3 of the gas emergency plan would trigger active rationing by the state, some energy intensive businesses like BASF have already announced production cuts due to the gas price surge and German consumers will likely continue to face further energy price increases in the coming months.

Equities: Global equities were higher yesterday as the peak stagflation fears are rolling into a recession fear. Recession fear is not at all positive for equities but as the inflation and central bank over tightening risk abating the heavyweight and down-beaten defensive growth names get relief. On the flip side, cyclical value such as banks, materials and energy were heavily beaten again yesterday. MSCI energy is down more than 20% with oil price down a little more than 10%. The VIX index ticked higher yesterday despite the fact the US equities led the advances. In US yesterday Dow -0.6%, S&P 500 +1.0%, Nasdaq +1.6% and Russell 2000 +1.3%. The positive sentiment for Wall Street has carried over to Asia this morning with South Korea leading advances. Both European and US futures are higher.

FI: Yesterday, the recession fear theme intensified on surprisingly weak PMIs from Germany, France, Euro Area, and later also the US PMIs disappointed. The drop in services ahead of the expected strong summer months in Europe came earlier than anticipated and was the biggest surprise, which ultimately lead markets to reassess the amount of tightening that central banks ultimately are expected to do. The December ECB meeting pricing went 15bp lower to 156bp on the day yesterday. Unsurprisingly the traditional policy sensitive pivoting point, 5y, performed the most, by a massive 26bp rally in Germany! Spreads widened (BTPs-Bund spread +5bp) as credit risks were reassessed as well. For now, ECB's emergency meeting last week has capped the BTPs-Bund spread below 200bp, but markets are still looking for details.

FX: PMIs confirmed the global economy is not growing right now and this should continue to support USD over the manufacturing hubs such as EUR and/or SEK. Yesterday, Norges Bank surprised in a hawkish direction but EUR/NOK still ended the session unchanged.

Credit: Sentiment turned negative on credit markets once again with iTraxx main widening 2bp to 113bp while Xover widened by 7bp to 557bp. In the Nordic region some companies in the real estate sector saw significant spread widening on the back of the recent rise in interest rates and worsening macro outlook combined with low liquidity in the outstanding bonds.  

Nordic macro

Today we expect Norges Bank to hike policy rates for the fourth time in this cycle by 25bp. We expect NB to stick to its 'gradual' strategy but also open the door for an August hike. We expect a forward guidance signal of close to a 50/50 split between August and September as the timing for the next 25bp hike but still with a verbal guidance towards September. We expect the top point of the rate path to fall in the 2.50-2.75% range by end-2023 and that the subsequent inversion will prove steeper than in the March Monetary Policy Report leaving a close to unchanged end-point of around 2.3% in Q4 2025. The steeper inversion reflects a much worse employment-inflation trade-off than expected in the last monetary policy report. If this calls proves right it would be a disappointment to markets and lead to lower short-end rates. Admittedly, the balance of risk to our call is skewed towards a more aggressive NB.