Hawkish BOE is Expected, but the ECB may Pushback against the Market's Tightening Bias

Overview: The eurozone's unexpected rise in January CPI did not appear to change the swaps curve which has about 30 bp of higher rates discounted over the next 12 months. However, it underscored ideas that the ECB is going to be less dovish today.  After a bit of a wobble after the CPI report, Germany's two-year yield rose a single basis point to extend its advance for the seventh consecutive session. Germany's 10-year yield spent the entire session above zero for the first time since early May 2019.   However, it was poor earnings from the renamed Facebook that set the tone for today's risk-off posture.  The NASDAQ futures are off slightly more 2%, while the S&P 500 is off more than 1%.  Most Asia Pacific markets are still on holiday, but the Japan, Australia, and India bourses were lower.  South Korea re-opened with a nearly 1.7% gain. Europe's Stoxx 600 advance has stopped at three sessions.  Information technology is the biggest drag, and the benchmark is off around 0.7%.  Benchmark bond yields are narrowly mixed.  The US 10-year yield is hovering around 1.77%, while European yields are slightly firmer.  Of note, the German 2-year yield ended up extending its advance to a seventh day yesterday but is coming back softer today. The dollar is around 0.20%-0.40% higher against most major currencies. The New Zealand dollar and Swedish krona are the most resilient.  Another jump in Turkey's inflation (11.1% in January for a 48.69% year-over-year pace) has weighed on the lira.  The Russian rouble's five-day advance has been arrested.  It is off about 0.7%.  The JP Morgan Emerging Market Currency Index is softer for the second session.  It is paring the ~1.2% rise posted Monday-Tuesday.  Gold is straddling the 200-day moving average (~$1806) in quiet dealing.  March WTI has a heavier bias after having been turned back from almost $90 a barrel yesterday.  It is approaching the week's low near $86.35.  US natgas is retracing nearly a third of yesterday's 15.8% jump, while Europe’s benchmark is rising for the second session after sliding more than 19% in the first two sessions this week. Copper's three-day 4.2% rally is at risk. It is off about 1.1%.

Asia Pacific

Although Japan's flash service and composite PMI were revised higher, the sub-50 readings underscore ideas that the world's third-largest economy may be contracting here in Q1.  New social restrictions were imposed late last month and run toward the middle of February.  The service PMI was revised to 47.6 from 46.6.  It was at 52.1 in December. The final composite reading was 49.9, up from the preliminary estimate of 48.8, but well off the 5.25 reading at the end of 2021.  Japan's 10-year yield is trading sideways in the 0.17%-0.18% area after surging in the second half of last week and the start of this week.  

Ahead of tomorrow's monetary policy statement, the central bank is likely to see the poor final PMI readings as lending more credence to its reluctance to raise rates.  Like we saw in Japan, Australia's service and composite PMI were revised higher from the flash but still below the 50 boom/bust level.  The services PMI stands at 46.7, up from the lowly 45 flash reading, but well off the 55.1 seen in December.  The composite reading is 46.6, up from 45.3 preliminary estimate, and 54.9 at the end of last year.  Separately, Australia reported poor December trade figures.  Imports rose 1% after a revised 4% increase in November. Imports fared better, rising by 5% after a revised 8% increase in the previous month.  The net result was a smaller trade surplus. The surplus fell to A$8.36 bln from A$9.76 bln. It was the fifth consecutive month that the trade surplus fell. 

The dollar's four-day slide against the yen is stalling. It reached almost JPY114.15 yesterday and it is back near yesterday's highs near JPY114.80.  It is retracing about half of its drop.  The next target is around JPY115.00, which holds a $1.15 bln expiring option. The Australian dollar experienced a three-day bounce after falling nearly three standard deviations from its 20-day moving average before last weekend.  The bounce carried it from below $0.7000 to almost $0.7160 yesterday, where it stalled just ahead of the 20-day moving average.  There is an option for around A$610 mln at $0.7110 that has been approached. A break of $0.7100 may see losses initially toward $0.7070.  


There is little doubt that the Bank of England will deliver a 25 bp rate hike, which brings the base rate to 50 bp. Previously, the BOE signaled that the full maturing issues would not be recycled into new purchases once the base rate got there.  More forward guidance is likely to be forthcoming.  As we have argued, the way to normalize QE as a policy tool is to use it when needed and stop when it is not.  That is about stocks as well as flows.  The swaps market has almost 125 bp in hikes priced into the curve this year but is leaning toward a single hike next year.  That suggests a terminal rate around 2%.  The pre-Covid but post-Great Financial Crisis peak (2018-2019) was 0.75%. The swaps market also suggests a terminal rate for Fed Funds in the US around 2%. The cyclical peak in the US was reached in September 2018 with a Fed Funds target of 2.00%-2.25%.

Rising price pressures had seen the 12-month euro swap rate edge higher in the second half of December from -55 bp to almost -45 bp by the end of the year.  It was easy to dismiss this as year-end adjustments.  It crept up to almost -30 bp mid-January and spiked positive briefly (and euro popped above $1.14 for the first time in two months). The ECB seemed to push against the need for an early hike and the swap rate pulled to status quo ante but since January 24, when the FOMC began meeting, it has risen to -15 bp.  Without new staff forecasts there is not much the ECB can say or do.  

President Lagarde may explain the distortions and impact from energy.  Some may recall the ECB's rate hike in July 2008 as Brent approached $150 a barrel--between the failure of Bear Stearns and the collapse of Lehman.  Certainly, the ECB does.  Chief Economist Lane gave Lagarde ammunition recently to direct focus to the upcoming wage round.  In the rotating voting system at the ECB, Nagel, the new Bundesbank President cast a vote for the first time.  And for those that bemoan Weidmann's departure, to the extent that voting is necessary, Nagel is unlikely to vote much differently than Weidmann.  It may be a difference of style and attitude. 

The final PMI readings do not change the picture very much.  The takeaway is that the German economy appears to be recovering after contracting in Q4, but the periphery is struggling.  The eurozone service PMI (51.1 vs. 51.2 flash and 53.1 in December) and composite (52.3 vs. flash 52.4 and December's 53.3) is unlikely to be much of a factor in the ECB's deliberations.  German and French service readings were little changed from the preliminary estimate.  Italy and Spain's service PMIs were weaker than expected and fell below 50 (48.5 and 46.6, respectively).  The Italian composite held just above 50 (50.1), while the Spanish composite reading fell to 47.9 (from 55.4).  The UK's final services and composite PMIs were revised higher and negated the small decline reported in the preliminary estimates.    

The US 2-year premium over German is edging lower.  It is the fifth session without a gain.  It has narrowed by almost 20 bp to around 160 bp.  However, the risk-off mood is offsetting the differential impact on the exchange rate.  The euro settled above $1.13 yesterday for the first time since January 25 but has been unable to retain the foothold.  There are around 1.5 bln euros options between $1.1290 and $1.1300 that expire today. A dovish ECB could spur losses into the $1.1225-$1.1250 band.  Despite expectations for a hawkish BOE, sterling is trading softer.  It approached $1.3590 yesterday and is testing the $1.3550 area in European morning. Buy the rumor (of a hawkish BOE), sell the fact, could see sterling test the $1.3500 area. That said, a rally above $1.3600 would demand attention.  The euro-sterling cross may be caught between two expiring options today.  There is one set at GBP0.8300 for almost 715 mln euros and another at GBP0.8350 for about 415 mln euros. The euro has not traded below GBP0.8300 since March 2020.  


Although the White House and some observers played up the official data showing nearly 900k employees were absent from their jobs earlier this month due to Covid or taking care of people with Covid, the 301k loss of private sector jobs by ADP was still a shocker. Of course, it should be expected to be a short-term hit, and unwind in February and March.  Still, as the final PMI and service ISM will likely show, the US economy had lost some momentum into the end of last year.  The Q4 GDP growth was flattened by inventory restocking.  The flash reading of the composite January PMI stood at 50.8, down from 57.0 in December.  It fell in December for the sixth time in seven months.  The ISM services index fell to 62.3 at the end of last year from 68.4, and it was the lowest reading since last August.  The US also reports weekly initial jobless claims, but they are overshadowed by tomorrow's national report.  The Q4 productivity and unit labor costs are derived from the GDP figures and typically are not market movers, even if they weren't competing with the ECB's press conference for attention. December factory orders and durable goods orders are too historical to matter.  Confirmation hearings of Cook, Jefferson, and Raskin to the Federal Reserve Board may draw interest this afternoon, but don't expect much beyond commitment to fight inflation.  

Bank of Canada Governor Macklem spoke late yesterday.  It is likely to follow the Bank of England and begin allowing its balance sheet to unwind shortly after the rate hike cycle begins.  The market is confident it will start next month. Macklem acknowledged that the labor market has recovered from Covid and the key to the rate path are productivity gains. Like the ECB's Lane, the labor market is still seen to be the key to the outlook for inflation and the hope is that productivity gains outstrip wage increases.  Although economists talk about higher wages pulling potential employees into the workforce in the US and Canada, note that wage increases continue to be outstripped by inflation.  That is to say real wages are falling. 

The focus in Mexico is on next week's inflation and Bank of Mexico meeting.  With a small contraction reported in Q4, a softer inflation report might take some pressure off the new Banxico Governor from hiking rates 50 bp.  Headline CPI is expected to soften to around 7% from 7.36% in December.  Brazil delivered its third 150 bp rate hike in a row but signaled a slower pace going forward. It has hiked rates 875 bp since last March.  The central bank referred to the cumulative effect of the rate hikes.  Many look for a 75-100 bp hike next month that could be the last.  

The US dollar is poking back above CAD1.27 in the European morning.  Nearby resistance is seen in the CAD1.2725-CAD1.2740 area.  The intraday momentum indicators are a stretched. Initial support is seen in the CAD1.2670-CAD1.2680 area.  A break of CAD1.2650 seems unlikely until tomorrow's employment data.  The greenback is trading inside yesterday's range against the Mexican peso (~MXN20.48-MXN20.6430).  We have an upside bias and a move above MXN20.65 could see MXN20.75. 


Hawkish BOE is Expected, but the ECB may Pushback against the Market's Tightening Bias Hawkish BOE is Expected, but the ECB may Pushback against the Market's Tightening Bias Reviewed by Marc Chandler on February 03, 2022 Rating: 5
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