Rates Spark: No Fireworks

There was little by way of signaling from the ECB yesterday, but the tone was slightly more optimistic. Market reaction was sanguine, showing sentiment doesn't require imminent monetary support to stay afloat, for now. The Fed's balance sheet shows a further easing in the need to support Wall Street. And money market funds are seeing more outflows.

Source: ING, ECB

Optimistic ECB and no market reaction

At its September meeting, the ECB almost perfectly fulfilled expectations of no policy change, and of a slightly more optimistic tone. Absent any new measure, attention was squarely on the staff economic projections and the policy implication they may have. There the tone was more upbeat than in June, with upward revisions to headline and core inflation forecasts, even if still way off target. During the Q&A, ECB President Lagarde reinforced that impression in stating that deflationary risks have receded.

If there was a more dovish part in the central bank’s communication, it was to be found in its warning that the EUR strength posed downside risks to prices. We refer our readers to our FX team for the significance of these comments on future movements in the currency. As far as rates are concerned, we doubt the market will read much into those comments, and so the hawkish reading of this meeting is what will remain.

A Bloomberg story citing governing council (GC) sources seemed to confirm this view, saying the central bank was prepared to 'look through' the EUR strength. There were also separate reports of a wing of the GC pushing for a more upbeat economic assessment. Given the lack of action at this meeting, we think reports of ECB divisions shouldn't be exaggerated, but one might get a better feel for the range of opinions as a host of ECB speakers are scheduled today at a Bundesbank event.

To be fair, market reaction has been more sanguine than could have been feared. Sovereign spreads ended the session tighter after a difficult week, and core yields continued their rise. Interestingly, 10s30s flattened on a sell-off. It is too early to call this a regime change (from the current bear-steepening/bull-flattening regime) but this is one further hint that markets can deal with an ECB that isn’t entirely convinced more easing is necessary.

Fed corporate credit buying slows, USD swap lines down and money funds see outflows

The latest from the balance sheet of the Federal Reserve shows more of the same. Buying of corporate credit was just $85m, reflective of the generally sub-$100m per week buying pace of the past three weeks. This remains an exercise of little toe-dipping; effectively the Fed programme is buying practically nothing. No big surprise here as the credit market has been standing on its own two feet for months now, and the primary market remains very busy and is being reflected in robust ongoing inflows into corporate bonds.

Also notable is the ongoing reduction in support for off-shore USD needs, primarily as these needs are no longer there. Again, not a new theme – it's been a factor in the past few months, ever since the scramble for dollars subsided on aggressive help from the Federal Reserve through its swap line. This is down another $16bn, to the $70bn area. Remember, at the height of the COVID breakout this facility was up in the $450bn area, at a time when there was a mad scramble to get access to USD liquidity.

Meanwhile, other elements of note are ongoing reductions in support for money market funds. At the same time, we note that prime funds continue to see outflows, with another $6bn of outflows for the latest week. This is quite different from the panic liquidation of some $150bn when the COVID crisis broke, and corporates liquidated to access emergency cash. But it is indicative of a reduction in interest in prime funds. That said, it extends into government funds too, as they are also seeing outflows. Cash is going into risky duration instead.

Today's events: US inflation, UK monthly GDP, ECB speakers, and Eurogroup

Following the ECB meeting, the focus will stay on the public appearances of governing council members today. It will be a busy slate with Villeroy, Weidmann, Schnabel, Mersch Holzmann, and Chief Economist Lane also scheduled to speak today even though some of the events are not directly on policy-related topics. Headlines on could also emerge from today's Eurogroup meeting on the fiscal response to the crisis.

In data, US CPI is in the spotlight after the Fed’s recent framework review that included a formal adoption of average inflation targeting. PPI data yesterday was already slightly higher than expected and our economist expects also inflation to continue rebounding in August, reflecting lagged effects of supply constraints relating to COVID containment measures amidst the re-opening of the economy. But he adds this won’t last given a 10% smaller economy and 12 million fewer people in work. 

In the UK monthly GDP data for July is likely to show that the economy rebounded by another 6-7% during the month, given that many lockdown measures were eased then.