BONDS: EGBs-GILTS CASH CLOSE: Relief Rally As US CPI Comes In Low
Gilts and EGBs soared Wednesday after the much-anticipated US CPI report proved benign for bond markets.
- Gilts initially strengthened after December CPI readings came in lower than expected, but reversed lower as the reading appeared to have been skewed downward by volatile components (namely airfares). They would recovered but set back anew on a weak Jul-34 Gilt auction.
- Ultimately though, a US CPI report on the soft side of expectations triggered a sizeable global FI relief rally, in which Gilts outperformed peers across the curve after weeks of underperformance. UK yields ticked up toward the cash close amid a speech by BoE dove Taylor, but the move looked driven by external factors rather than the speech itself. The UK curve bull flattened overall.
- Bunds largely tracked the wider global moves. The German belly outperformed on the curve, with EGB periphery spreads narrowing sharply as risk-sensitive assets rallied.
- Thursday's schedule includes UK monthly activity data and final German and Italian inflation, as well as the accounts of the December ECB meeting.
Closing Yields / 10-Yr EGB Spreads To Germany:
- Germany: The 2-Yr yield is down 6.2bps at 2.257%, 5-Yr is down 9.9bps at 2.363%, 10-Yr is down 9.8bps at 2.554%, and 30-Yr is down 7.5bps at 2.781%.
- UK: The 2-Yr yield is down 13.6bps at 4.469%, 5-Yr is down 14.2bps at 4.471%, 10-Yr is down 15.6bps at 4.733%, and 30-Yr is down 14.7bps at 5.302%.
- Italian BTP spread down 4.9bps at 113.9bps / French OAT down 3.4bps at 79.7bps
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ECB: Hawkish Strands Still Prevalent In Schnabel Speech
Schnabel echoes the broader Governing Council view that price stability is within reach and a further dialling back of policy restriction is towards neutral is appropriate. In line with her previous comments, there is little indication that she would support cutting rates into accommodative policy i.e. below neutral.
The speech cites ECB analysis which estimates nominal neutral interest rates between 1.50% and 3.00%. A reminder that in an interview with Bloomberg on November 27, she said that “We may not be so far from the neutral rate, which I would put into a range between 2% and 3%”. Various strands in today’s speech suggest this view still holds:
- She caveats that although services inflation momentum has started to ease, “such signals critically depend on the way the seasonal adjustment is done”.
- Additionally, she notes that “new shocks keep hitting the euro area economy, many of them posing upside risks to inflation” and that the depreciation of the EUR since the Us election “is already putting upward pressure on import prices”.
- “Given the notable increase in real short-term rates expected to prevail in the distant future, which are often taken as proxies for the natural rate, the policy stance today may already be in neutral territory”.
- Finally, she re-iterates the idea that expansionary monetary policy is ill-suited to dealing with structural headwinds, which are a large driver of weak confidence and spending in countries like France and Germany.
OPTIONS: Larger FX Option Pipeline
- EUR/USD: Dec18 $1.0550-65(E1.6bln); Dec20 $1.0420-40(E5.4bln), $1.0443-50(E4.9bln), $1.0500(E7.2bln), $1.0525(E3.4bln), $1.0550-55(E3.2bln), $1.0600(E3.7bln)
- USD/JPY: Dec19 Y155.00($1.5bln), Y158.00($1.1bln); Dec20 Y150.00($1.7bln), Y150.65($1.3bln), Y155.00($1.0bln), Y156.00($1.3bln), Y157.00-05($2.6bln)
- GBP/USD: Dec18 $1.2800-15(Gbp1.4bln)
- EUR/GBP: Dec20 Gbp0.8290-00(E2.6bln), Gbp0.8345(E2.0bln)
- AUD/USD: Dec20 $0.6494-00(A$2.0bln)
- NZD/USD: Dec20 $0.5850-60(N$1.0bln)
- USD/CAD: Dec20 C$1.4200($2.4bln)
ECB: Schnabel Stressed The Importance Of Gradualism As Rates Approach Neutral
ECB Executive Board member Schnabel's speech on "Navigating towards neutral " here. Overall, she stressed the importance of a gradual removal of policy restriction as rates approach neutral. She does not provide an explicit view on she views neutral is though, only cites ECB analysis where neutral ranges from 1.5-3% in nominal terms.
- "Our decision last week to cut our key policy rates by 25 basis points reflects the conviction that a gradual and data-dependent approach remains the most appropriate strategy"
- " Even if most of the evidence points to continued disinflation, we should remain alert to signs that cast doubt on our baseline"
- "While the direction and persistence of the various effects of potential tariffs on inflation are ambiguous, their net effect is often estimated to be positive".
- "Recent analysis by ECB staff across a suite of models suggest that the point estimate of r* ranges from about -0.5% to 1%, or about 1.5% to 3% in nominal terms"..."Significant parameter uncertainty makes it even more challenging to use the natural rate as a guidepost for monetary policy".
- "Given limited policy space, monetary policy should focus on responding forcefully to shocks that have the capacity to destabilise inflation expectations by pushing inflation measurably and persistently away from our 2% target over the medium term".
- "Monetary policy is not a supply-side instrument. It cannot resolve structural issues that durably weigh on price pressures"
