Powell signaling that rate hikes are still some time off has calmed nerves somewhat. The discussion of earlier hikes is ongoing at the BoE, though we do not expect new hints at this meeting. The ECB is resisting upward pressure as the recovery plods on, with today's PMIs set to show another advance.
Smoothing over the waves
10Y UST Treasury yields edged lower in the wake of Fed Chair Powell's testimony and the policy-sensitive 5Y sector continued to edge back from its cheaper levels. Powell’s base case remains that the price increases triggered by the reopening of the economy will eventually fade, and he reiterated that the Fed will not act preemptively but wait for the actual evidence of “imbalances” in the data. The nuance was that he acknowledged the reopening effects were stronger than expected and also could turn out to be more persistent. However, smoothing over the recent waves in financial markets bodes well for market sentiment and could help save market participants’ carry prospects over the summer.
The Fed will not act preemptively but will wait for the actual evidence of “imbalances” in the data
The mood of music in Europe seems to be improving amid slowing infection rates and the accompanying reopenings. A case in point was yesterday’s surging consumer confidence data reading that bodes well for business sentiment and the services sector in particular. The fly in the ointment is the supply constraints holding back the manufacturing sector – the consensus is for the sector PMIs to have retreated over June - and one eye will also be on the price components which have been on a rise for similar reasons.
Powell has helped stop the curve flattening but 2Y swaps held on to their gains
Source: Refinitiv, ING
The apparent consensus among policy makers to allow an inflation overshoot has helped flatten EUR curves again
For the ECB, this means there is a build-up of pressure on rates, which it currently counters with continued dovish rhetoric after only recently having extended the faster pace of asset purchases for another quarter. Reuters reported on the ECB’s ongoing internal discussions surrounding its future inflation strategy. Not entirely new, but the apparent consensus among policymakers to allow an inflation overshoot has helped flatten EUR curves again - at least temporarily. It would reduce the risk of the ECB withdrawing accommodation too early. And as we pointed out yesterday there is still some room for market participants to price in higher QE purchases for longer given that consensus seems to see no increase in APP to cushion the planned end of net-PEPP after Q1 next year. While in the end that may not prevent rates edging higher as the macro backdrop improves it should at least help keep curves flatter and shield EGB spreads from widening pressure.
Tomorrow's BoE meeting – with a risk that the market is too far ahead already
Recent developments warrant a closer look at the policy-senstive parts of the GBP curve: The 2s5s10s GBP fly has richened back only moderately after repricing cheaper in the wake of the FOMC meeting, the two-year swap rate only minimally so. That means going into tomorrow’s BoE meeting the market is still very much in the mind of anticipating a faster policy tightening. The danger is that this is overstating the implications of the Fed’s hawkish U-turn for BoE policy, as we have written before in our dedicated meeting preview.
The BoE itself has already endorsed market pricing rate hikes by mid-2023. While not dismissing risks of an earlier hike, that is also the camp our economist is in for now. An argument for waiting is that the BoE for now looks set to shrink the balance sheet first. Secondly, rising Covid cases put the reopening agenda at risk. Even if it is too early to draw firm economic conclusions, a more cautious tone may well impact rates earlier than economic data are impacted.
Today's events and market view
The PMI releases are the highlight of the day with the consensus looking for another set of strong readings amid reopening economies. The only blemish are supply constraints weighing on the manufacturing sector. These prospects should be baked into prices by now although today's supply may still aid a resteepening of curves. Eventually, that could give way to a calmer summer ahead with the ECB assuring its dovish backdrop.
Germany will reopen its 15Y bond for €2.5bn. Note that Germany moderately increased its funding plans for the upcoming quarter by €2bn to €62bn.
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