We have seen flatter yield curves this week on a series of weaker than expected US data releases. In particular, the housing market is gaining increasing attention as soaring mortgage rates weigh heavily, with new home sales down 10.9% in September, as well as falling prices, which may soon be reflected in consumer demand. It also weakened the dollar which traded around parity against the euro as markets begin to price in a potential slowdown in the pace of Fed tightening. The stock market trend that “bad data is good data” as long as yields go down continued, and stocks had a good week overall.
As widely expected, the ECB raised its key rate by 75 basis points and guides the markets for further rate hikes to come. The ECB will set the pace of the hike with the economic outlook in mind, which is a clear indication of a slowing up cycle, and the market also priced nearly 25 basis points of ECB hikes. The ECB also announced changes to the conditions of the TLTRO, which will lead to a significant drop in excess liquidity from 23 November. The Danmarks Nationalbank followed suit but only with 60 basis points in order to bring the EUR/DKK out of the lows for good.
The economic contraction in the euro zone continued for the fourth consecutive month, with the October PMI index falling further to 47.1. The contraction was particularly due to a weaker than expected manufacturing sector. Germany is probably the weakest link, and Ifo data also confirms that Germany is heading into recession in H2. Supply bottlenecks are indeed showing new signs of easing, but weaker demand does not yet appear to have materially weakened corporate pricing power, leaving inflationary pressures elevated.
After the continued weakening of the yen, the Bank of Japan (BoJ) intervened in the foreign exchange market several times over the past week. Meanwhile, the BoJ is pumping yen into the market to defend its control of the yield curve, while the government prepares a $200 billion (4% of GDP) spending package to ease the pain of energy bills .
Next week, the FOMC meeting is the main event for the markets. It’s too early to soften the Fed, and we expect a 75 basis point hike and hawkish communication. We also expect to see a relatively strong jobs report later next week. In the UK, the Bank of England will also need to tighten further to bring down inflation and wage growth.
In the Eurozone, the highlight will be the HICP figures for October. Given the strong underlying inflationary pressures, we expect core inflation to continue to rise to 4.9% and that HICP inflation is likely to rise above the 10% mark. Q3 GDP figures could show a recession started to set in in H2 22, but a late rebound in industrial production amid easing supply bottlenecks poses risks on the rise. In China, we will be watching the PMI data, and we see some downside risks as weak exports now add to headwinds from the housing crisis and zero-Covid policy.
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