There’s No Stopping the Core Bond Sell-off for the Moment

Markets

There’s no stopping the core bond sell-off for the moment. UK Gilts remain underperformers with UK money markets betting on aggressive BoE action (4.5% policy rate peak mid-next year). Double digit inflation and the political blame game put BoE governor Bailey with his back against the wall. UK yields yesterday rose by 4.9 bps (30-yr) to 22.6 bps (3-yr). The German yield curve bear flattened with yields ending up to 7.1 bps (2-yr) higher while US yields ended with around 6 bps gains across the curve. 10-yr yield spread changes vs Germany widened only marginally. Bond weakness yesterday didn’t spill to other markets. Main European and US equity benchmarks managed a slightly positive close. The dollar attempted to set new YTD highs on a trade-weighted basis (DXY 109.30) and against the euro (EUR/USD 0.9901), but didn’t succeed, prompting return action during US dealings and this morning. EUR/USD is currently changing hands a tad below parity. Sterling again didn’t benefit from the relative yield dynamics with EUR/GBP closing just below 0.8450. Brent crude broke above the $100/b mark, currently approaching $102/b on fears of reduced supply coming from OPEC+.

Today’s eco calendar won’t inspire trading. Details of Q2 German GDP (0.1% Q/Q from 0%) showed decent consumption (0.8% Q/Q), a big push in the back from the government (2.3% Q/Q) and a drop in investments (-1.3% Q/Q). German Ifo business sentiment loses relevance following PMI figures earlier this week. Minutes of the ECB meeting will be an interesting reading, but might prove outdated already. Since yesterday, money markets for the first time fully embrace the idea of additional 50 bps rate hikes at both the September and October ECB policy meetings. German members Schnabel and Nagel (Bundesbank) already backed a 50 bps hike in September. The countdown to Powell’s Jackson Hole address keeps core bonds under pressure. We still see a possibility to surprise on the hawkish side in case of a nod in the direction of a higher neutral rate. The median projection in the June FOMC dot plot was “only” 2.4%.

News Headlines

The Bank of Korean this morning raised its policy rate by 0.25% to 2.50%. As such the central bank returned to a more normal pace of adjustment after an exceptional 50 bps move in July. The BoK raised its 2022 inflation outlook to 5.2% from 4.5%. At the same time, it cut the projection for 2022 growth to 2.6% from 2.7%. Growth is expected to slow further to 2.1% next year. Governor Rhee at the news conference confirmed the BoK’s intention for further tightening. He said that as long as growth “stays relatively sound compared with other countries, making sure inflation is under control first would be helpful for everyone in the medium-to long-term”. In this respect he saw market expectations for the policy rate to move towards 2.75%/3.0% by year-end as appropriate. After reaching a multi-year low against the dollar earlier this week, the won this morning gains about 0.5% to USD/KRW 1336,25. The BOK repeated that it doesn’t target a level for the currency but it is taking the impact of the won valuation on inflation into account.
 
The Chinese state council yesterday approved a 19 point policy package to further stimulate economic activity. The government foresees a further 1tn yuan funding amongst others, to support infrastructure spending. Local government will get access to 500bn from previous unused quota. The state council indicated the government will take “timely and decisive measures, maintain a reasonable policy scale and make good use of policy tools in the toolkit, and intensify efforts to consolidate the foundation for economic recovery”. At the same time, the government will avoid to flood the economy with excessive stimulus.