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Sunset Market Commentary – Forex Action

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Recent the underperformance of EMU bond/interest rate markets relative to the US continues. European investors closely followed the comments and speeches at the ECB forum in Sintra. Before and at the June 9 policy meeting, the ECB has already provided a fairly detailed roadmap signaling a 25bps rate hike in July and (several) steps >25bps later this year if the inflation does not improve significantly by then. If the consensus on Friday’s CPI release (0.7% M/M, 8.5% Y/Y) holds true, this improvement won’t materialize any time soon. In this regard, the ECB’s Lagarde reiterated the benefits of gradualism, but at the same time stressed ‘the ability to act decisively on any deterioration in inflation over the medium term, especially if there are signs that inflation expectations are unanchored‘. Latvian ECB member Kazaks even argued the merits of a bigger rate hike as early as the July meeting, but there are few signs that his view holds a majority within the MPC. President Lagarde and other governors have also drawn up measures to avoid the fragmentation of politics between countries. This is even now seen as a necessary condition for being able to raise rates enough to deal with high inflation. A first line of defense with flexible reinvestments of maturing bond proceeds from the PEPP portfolio will begin as early as July 1. Regarding the new tool being prepared to manage the unjustified widening of spreads, the ECB President said: ” The new instrument will have to be effective, while being proportionate and containing sufficient safeguards to maintain Member States’ momentum towards sound fiscal policy‘. Thus, some conditionalities, although flexible, will apparently be included. Some members of the ECB have also came up with the idea of ​​sterilizing the liquidity created via the new tool. Sintra’s news shouldn’t come as a big surprise to the markets. Still, the idea that the ECB’s new toolkit makes it easier to hike rates without market fragmentation could fuel expectations of bolder ECB action if the inflation outlook deteriorates further. German rates increase between 5.5 bps (2 years) and 8.5 bps (10 years). The sharp rise in the 5-year rate (+14 bps) is partly due to a change in benchmark. The EMU yield floor after last week’s correction is clearly taking shape. The tightening of intra-EMU spreads against Germany also continues (Greece 10 years -7 bps, Italy -4 bps). Movements in the US bond market were again much more muted, with the 2-year yield little changed while yields on longer maturities rose by around 2 basis points. European equities continue a cautious rebound (Eurostoxx +0.75%/1.0%), but the LT picture remains fragile. US stocks post similar gains after the open. Oil is also gaining ground (Brent $117/b).

In the foreign exchange markets, the the forint rebounded to EUR/HUF 398.75 after the MNB unexpectedly raised its key rate by 185 basis points to 7.75%. It will bring the 1-week deposit rate back to the same level in its weekly tender next week. EUR/USD tried to find the 1.06 handle this morning. However, the additional interest rate support failed to trigger an upside breakout. Profit taking even brings the EUR/USD back to the 1.0540 area. EUR/GBP is also trading intraday peak levels, but is little changed from a daily perspective (0.862). USD/JPY (136.15) close to multi-year high again.

News headlines

Polish Monetary Policy Council member Kotecki argued for a rate hike of at least 100 basis points at his July 7 policy meeting as he expects another sharp rise in inflation in early 2023 due to higher electricity and gas prices. Kotecki is among the more hawkish members of the board, with Governor Glapinski hinting earlier that the tightening cycle may be coming to an end. Polish inflation figures are due out on Friday and are expected to rise by 1.5% M/M and 15.5% Y/Y. The National Bank of Poland implemented monthly rate hikes of 75 basis points this year starting in March, with even a rate movement of 100 basis points in April. Jhe base rate is currently 6%. Accelerating inflation and more drastic action in June by the CNB (+125bps at 6%) and the MNB today (+185bps at 7.75%) suggest that the risks are clearly oriented towards more aggressive action. Polish money markets update a policy rate above 8% by the end of the year and peaking at 8.5% by the middle of next year. The Polish zloty could benefit from the additional support. At EUR/PLN 4.7, it remains in the danger zone of falling back to the lowest levels on record. The NBP believes that a (stronger) currency should be part of the equation in the current market environment (high inflation and aggressive tightening cycle)...

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