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The Setback In Yields To Be Corrective/Temporary In Nature

Markets

Moves on the interest rate markets yesterday suggested that investors still have to navigate a complex of unsure, potentially conflicting, factors. The US curve continued Tuesday’s flattening trend. The US inflation data supported the move, but were not the trigger as the tone was already set before the publication of the data. US September CPI printed marginally higher than expected at 5.4 Y/Y for the headline and 4% Y/Y for core. US yields (both long and short-term) jumped briefly higher but at the end of the day, the 2y yield was up 2bps while the 30y yield declined 6.7 bps! The move at the long end of the cure was supported by a strong US 30y auction. Interestingly (and remarkably), the decline in long term yields was mainly driven by a sharp setback in real yields. Inflation expectations even rose slightly. Several interpretations are possible, but it might suggest that markets ponder a scenario where lower growth can make it difficult for the Fed to start a protracted rate hike cycle after finishing tapering. The Fed minutes indicated that the US central bank will almost certainly start reducing net asset purchases starting mid-November or mid-December at a monthly pace of $15bn (10bn Treasuries, 5 bn MBS). Contrary to Tuesday, European/German yields yesterday followed the broader (corrective?) flattening move with yields declining between 0.7 bps (2y) and 7.7 bps (30y). This halts the recent impressive uptrend in both the 10y German yield and the 10y EMU swap, but for now the technical picture isn’t fundamentally hurt. Equities rebounded on the setback in yields (S&P 0.30%, Nasdaq 0.73%). Despite higher US short-term yields, the dollar fell prey to modest profit taking. DXY closed at 94.08. EUR/USD finished near 1.159. USD/JPY closed near 113.25.

Most Asian markets this morning join the European/US risk rebound. China underperforms. Chinese price data painted a mixed picture with PPI accelerating to 10.7%, but CPI slowing slightly from 0.8% to 0.7%. The dollar remains in the defensive (eg. EUR/USD near 1.1590). Today’s eco calendar contains US jobless claims (expected to ease to 320k) and US PPI (expected to rise further). US (and to a lesser extent German) yields as indicated have to cope with conflicting considerations. Technical factors are probably also in play (German 10y yield nearing the post-corona top of -0.07%). Given the ongoing debate on inflation, we expect the setback in yields to be corrective/temporary in nature. The dollar failed to take out important resistance (DXY 94.47/74 area , EUR/USD 1.1495 area). The jury is still out, but a return of EUR/USD above the 1.1640/64 area would be a first indication that the EUR/USD downside momentum is easing. Is enough good (interest rate) news discounted for the USD currency?

News headlines

Australian employment again fell in September with 138 000 jobs after the 146.3k job loss the month before. The decline was unsurprising given the lockdowns in the two largest states of New South Wales and Victoria and in the nation’s capital. It was, however, more than the anticipated 110 000. Part-time jobs were shed (-164.7k) while fulltime employment recovered 26.7k from the 68k loss in August. Total employment has now fallen back below prepandemic levels, as did hours worked. The unemployment rate rose from 4.5% to 4.6%. That smaller-than-expected increase followed a below-consensus participation rate of 64.5% (down from 65.2%). The Aussie dollar dipped in the wake of the release before recovering back to near-intraday highs of AUD/USD 0.739.

The Turkish lira yesterday late finished with a new all-time low vs the dollar and came close to the previous one in EUR/TRY after Turkish president Erdogan sacked three members of the monetary policy panel in the Turkish central bank. Two of them were deputy governors with one (Kucuk) being the only member of the committee to have voted against the interest rate cut last month, according to people with knowledge of the matter. It is well known that Erdogan seeks lower policy rates to stoke growth at all costs, regardless of spiraling inflation. The move alerts investors who fear more rate cuts are on the horizon. The lira extends losses this morning to USD/TRY 9.14 and EUR/TRY 10.61. The CBRT meets on October 21.