EUR/USD Failed Attempt to Break Through 1.10
It didn't quite turn out the way we expected. Particularly in the bond market. Fed Chair Powell and ECB Lagarde both passed up an opportunity to rally markets around their preferred monetary policy paths. Given the absolute level of the policy rate and the fact that core inflation is beginning to fall, we follow some of Powell's "caution" in the US.
Nonetheless, market pricing continues to be at odds with the Fed's intention to deliver multiple rate hikes (2 times 25 bps as envisioned in December dot plots). In the case of Europe, we are astounded by the bond rally seen yesterday, even as ECB Lagarde, initially reluctantly but later decisively, pushed back against the notion of reaching a potential peak rate (soon) after March and cutting rates soon after.
Core inflation in the eurozone is still rising, and the ECB wants to be certain that inflation is back at 2% - "not just for weeks or even months" - before reversing course. Our longer-term view on bonds, particularly European bonds, remains bearish, but we acknowledge that short-term momentum could be more neutral or even bullish, especially if there are some negative economic surprises.
The US payrolls report and non-manufacturing ISM in the US this afternoon could be a litmus test. The consensus forecast is for another strong job gain (+189k), with wages expected to maintain their monthly dynamic (0.3% M/M; down to 4.3% Y/Y). Markets have been focusing on the weaker parts of payrolls and household surveys in recent months, whether it was job growth or wage growth.
The services ISM is expected to rise slightly above the 50 boom/bust level. This week's stock market is soaring. Yesterday, the main European indices gained up to 2%, while the US performance ranged from flat (Dow) to +3.25%. (Nasdaq; following Meta earnings). Our longer-term outlook is similar to that of bond markets.
Disappointing earnings from other big tech names (Apple, Amazon, Alphabet) have already pushed US equity futures lower this morning. Despite a better-than-expected Caixin services PMI, China underperforms (52.9 from 48 vs 51 expected). In FX, we've seen a (so far) unsuccessful attempt by EUR/USD to break through 1.10. (close to 1.0910). A balance of weakness, with the euro eventually reversing its post-ECB bond outperformance.
German yields fell 12.7 basis points (30 basis points) to 22 basis points (7 basis points) yesterday, compared to a maximum of 2.8 basis points (5 basis points) for the US. 10-year yield spreads versus Germany have narrowed to around 9 basis points for countries such as Greece, Portugal, and Spain, with Italy outperforming (-19 bps).
The EUR/GBP broke through the 0.8897 January high as the Bank of England effectively suggested that the March rate hike will be the last (conditionally). Relative yield dynamics will work against the pound, which is also facing a bleak economic outlook. If confirmed, the break suggests a quick return to EUR/GBP 0.90+ levels. The previous year's high was 0.9266.