recession economy

10 Year Treasury reaches 5%, an alarm for risky assets

The 10-year Treasury bond yield is widely recognized as the benchmark for the global cost of capital and a measure of risk-free returns. Consequently, the disparity between the earnings yield of the S&P 500 index and the yield on the 10-year Treasury bond represents the risk premium associated with stocks.

Stock risk represents the degree to which stocks are perceived as an appealing investment in comparison to other asset classes. In the present circumstances, stock risk has plummeted to near-zero levels, signifying that stockholders are not being rewarded for assuming additional risk. This situation has created significant pressure within the stock market.

The current level of risk is at its lowest point in the past two decades. This decline in risk can be attributed to various factors, including the rise in the dollar index. However, this situation carries substantial implications, particularly for economically disadvantaged countries. It makes it increasingly challenging and costly for these nations to service and repay their debts.

The convergence of these factors, with stock risk hitting historic lows and the strengthening of the dollar, underscores the complex dynamics impacting both global financial markets and the economic well-being of nations with high debt burdens.

This phenomenon demands careful monitoring and analysis as it can have ripple effects throughout the financial world and international debt markets.

The yield curve is the difference between the yields of ten-year and two-year bonds; In normal economic conditions, naturally, the yield of ten-year bonds should be higher than the yield of two-year bonds.

Inversion means that the yield of two-year bonds is higher than the yield of ten-year bonds; Since the 1970s, whenever there has been an inversion of the yield curve, we have seen a recession in the coming months.

Due to the existence of inflation and the increase in yield of bonds due to the increase in interest rates, it is not possible to get a definite recession signal from the current inversion and more data needs to be examined.

A recession is a period of economic decline characterized by a decrease in economic activity, rising unemployment rates, and reduced consumer spending. During a recession, the concept of the “Dollar smile” refers to a graphical representation of the U.S. dollar’s exchange rate. It illustrates that the dollar tends to strengthen during both economic downturns and periods of strong economic growth, forming a smile-like shape on a chart. This phenomenon suggests that investors often seek the safety of the U.S. dollar as a global reserve currency during times of uncertainty, making it a preferred asset in their portfolios.

The risk of recession is closer than ever

A sharp inversion of the yield curve and the possibility of recession

The yield curve is the difference between the yields of ten-year and two-year bonds; In normal economic conditions, naturally, the yield of ten-year bonds should be higher than the yield of two-year bonds.

Inversion means that the yield of two-year bonds is higher than the yield of ten-year bonds; Since the 1970s, whenever there has been an inversion of the yield curve, we have seen a recession in the coming months.

Due to the existence of inflation and the increase in yield of bonds due to the increase in interest rates, it is not possible to get a definite recession signal from the current inversion and more data needs to be examined.

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ECB rate hike But makes EUR weak!

This rate hike, is the tenth consecutive policy rate hike since July last year, hiking all interest rates by 25bp and the rate is 4.5 right now. Higher inflation and inflation forecasts look like the main drivers of the hike. The ECB’s communication is clear: today was the last hike in the current cycle

This announcement could potentially lead to some market reactions. Traders, accustomed to these consecutive rate hikes, may view this as the end of the cycle. Consequently, the EUR currency might experience a weakening effect. As a result, it is important for market participants to adjust their strategies accordingly, considering the implications of this final rate hike by the ECB.

The European Central Bank (ECB) decided to raise interest rates for the tenth consecutive time since last July. This move was driven by a greater concern about the fear of not fully controlling inflation and the risk of ending the rate hikes too soon, rather than the increasing risk of recession in the eurozone. Following a total increase of 450 basis points, the ECB’s main policy rates are now at a historic high.

More insights into the reasons behind this decision and the discussions that took place will be shared during the press conference, scheduled to begin at 2:45 pm CET. At the moment, it is evident that the ECB is deeply troubled by inflation. This includes both the current inflation rate and the anticipated future inflation, as indicated by the latest ECB staff projections, which foresee headline inflation reaching 3.2% in 2024.

You might be wondering why the ECB isn’t taking a step back and waiting to assess the full impact of the previous rate hikes. The answer is straightforward: it’s about maintaining credibility. The ECB’s primary responsibility is to ensure price stability, which the eurozone has not experienced for nearly three years. While the recent surge in inflation is primarily influenced by factors beyond the ECB’s direct control, the ECB must demonstrate its commitment to curbing it. The potential consequences, such as a more pronounced economic slowdown in the eurozone, are of lesser concern to the ECB, at least for now.

Looking ahead, if the economy weakens further and a disinflationary trend gains momentum, it will become increasingly challenging to justify additional rate hikes before the year’s end. The official communication’s statement that “based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target” suggests that today’s rate hike may well be the final one.

In summary, today’s interest rate hike not only bolsters the ECB’s credibility but also signals the end of the current rate-hiking cycle.

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federal reserve

FED interest rate hike probability

Based on the latest market pricing, the probability of an interest rate hike by the Federal Reserve in November has increased to 52%

The rise in expectations followed a surprise survey of the services sector by the Institute for Supply Management in August, which showed an acceleration in economic activity, including prices paid. The overall index rose to 54.5 from 52.5, and the prices sub-index increased from 56.8 to 58.9, reflecting rising price pressures in the economy. Market participants are currently grappling with uncertainty about how much the Federal Reserve will raise interest rates and how long interest rates will remain high. Federal Reserve officials have made it clear they will keep interest rates on hold for now, but will closely monitor economic data to determine their next steps. While some economic indicators have begun to moderate, the strong performance of the US services sector serves as a forward-looking indicator of continued economic strength.

An interesting perspective to consider is that earlier in the year, there was considerable talk of an impending recession, causing companies to take a cautious approach and potentially causing consumers to cut back on spending as well. However, the predicted recession never materialized and companies now find themselves with empty inventories but still experiencing high demand. As a result, they are putting aside their previous concerns and are actively investing in replenishing their inventories. It is important to realize that most of the stagnation is caused by psychological factors and this psychological barrier may have been removed, at least from a business perspective.

However, the impact of higher interest rates on consumers, especially in terms of the affordability of items such as new cars and mortgages, can be a gradual process. The market is currently pricing in an 89 basis point cut in interest rates by December 2024, but that forecast still depends on how the economic data unfolds. The possibility of higher interest rates for a longer period is certainly a possibility. Currently, the key point of these developments is the strengthening of the dollar in the currency market; Because expectations of a possible increase in interest rates in November continue to affect currency valuation and financial markets.

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France: Inflation falls, but not by much, and consumption drops

Inflation decreased in France in March, thanks to base effects on energy prices. Nevertheless, underlying inflationary pressures remain very high and food inflation will continue to rise. GDP growth will therefore likely remain weak, as confirmed by the falling consumer consumption in February

Inflation falls, thanks to energy

As expected, headline inflation in France fell in March to 5.6% from 6.3% in February. The harmonised index, which is important for the European Central Bank, stands at 6.6% against 7.3% last month. This fall in inflation is mainly due to the base effects of energy prices, which rose in March last year when the war in Ukraine started. Energy inflation thus stood at 4.9% in March compared to 14.1% in February. Given the tariff ‘shield,’ which limited the increase in gas and electricity prices in France to 4% in 2022 and 15% in 2023, energy continued to contribute positively to French inflation, unlike in other European countries which saw energy bills fall in 2023 after the very sharp rise in 2022.

In addition, the government’s decision to raise tobacco prices pushed these prices up by 7.8% year-on-year in March (compared to +0.2% in February). Food inflation also continues to rise, by 15.8% year-on-year in March, compared to 14.8% in February. Food is now by far the largest contributor to inflation in France. At the same time, inflation in manufactured goods rose from 4.7% to 4.8%.

Despite the fall in headline inflation, underlying inflationary pressures remain very high. Consumer prices rose by 0.8% over one month in March, which is well above historical averages. The only positive element is the slight drop in services inflation, from 3% to 2.9% in March, due in particular to the fall in transport services prices, which indicates that the increases in the minimum wage have not led to a sharp rise in the prices of all services, so far. Transport also benefits from lower fuel prices.

What is the outlook for inflation?

In the coming months, food inflation is expected to remain the largest contributor to consumer price inflation in France. Despite the fall in world food commodity prices, food inflation will probably continue to rise in the short run. Indeed, the cost increases of recent months will continue to be reflected in food prices, as evidenced by the recent trade negotiations, which will lead to an increase in prices paid by supermarkets to their suppliers of around 10%. However, the impact of these negotiations is not expected to be immediate on prices but gradual during the second quarter of 2023.

Producer prices remain dynamic in industry, rising by 13% year-on-year in February compared to 14.5% in January, but are decelerating. This implies that inflationary pressures for manufactured goods will start to ease in the coming months. In addition, survey data for March indicates that fewer firms are expecting higher prices. Although price expectations remain historically high, they have started to decline in all sectors. Assuming that energy prices remain lower than in 2022, headline inflation is expected to average 5% in 2023 (5.9% for the harmonised index), with a marked decline from the end of the summer. Nevertheless, inflation should end the year above 3%.

Consumption declines

This expected decline in inflation is taking place against a background of slowing global demand, and growth, expected in France in 2023. The data on household consumption of goods for the month of February, published this morning by INSEE, confirms this once again. Consumer spending fell by 0.8% in volume over the month, following a 1.7% rise in January – a rise that was truncated by statistical effects linked to the disappearance of the energy voucher. Consumption is down in all product categories, and the drop is particularly strong in food (-1.2% over the month). Though services consumption probably held up better, household consumption will probably not be a strong driver of economic growth in the first quarter. We expect quarterly growth to be 0.1%, and the risks are tilted to the downside, particularly in view of the social unrest in March, which may have had a temporary negative impact on activity. Growth is not expected to be much more dynamic for the rest of the year, with activity hampered by rising interest rates, slow global growth, and the inflationary environment. We expect GDP growth to be weak at 0.7% for 2023 as a whole, and 0.7% in 2024 (down from 2.6% in 2022).

source: ING

Eurozone inflation is expected to decrease

Inflation is expected to fall sharply in March due to lower energy prices, according to preliminary estimate data from Germany’s six economic states on Wednesday.

The inflation rate in the state of Brandenburg and Baden-Württemberg fell to 7.8 percent year-on-year. Also, in Bavaria, Hesse, and North-Rhine Westphalia, the inflation rate decreased to 7.2, 7.1, and 6.9 percent, respectively, and in the eastern state of Saxony, the inflation rate decreased to 8.3 percent. In February, the inflation rate in these six states was between 8.3 percent and 9.2 percent. According to economists at ING, inflation in Germany and the eurozone is no longer the result of a supply shock, but a demand-side issue. Economists of this financial institution said that not only the price of energy and primary goods are passed on to consumers, but also the increase in profit margins in some companies has also added to the inflationary pressures. Given the developing growth-price and wage-price spirals in Germany, core inflation will remain stubbornly high.

The European Central Bank will continue to raise interest rates, at least through the summer, before entering a long period of higher interest rates. Labor forces are increasing their demands and wages and gaining bargaining power in a very tight labor market. Germany’s public sector wage talks failed to reach an agreement this week, although employers offered wage growth of roughly 6 percent a year for 2023 and 2024. Unions are in a stronger position, so we continue to assume that final wage growth will be higher than forecasts, said Christian Schulz, an economist at Citigroup Investment Bank. This directly increases inflation; Because local authorities have to increase administrative costs and health insurers donate higher contribution rates to pay for higher costs. While headline inflation is easing, core inflation is expected to remain elevated.

German inflation

German inflation drops but there’s no sign of broader downward trends

German headline inflation dropped in March to the lowest level since last summer. However, there are still no signs of any broader disinflationary trend outside energy and commodity prices

Has the disinflationary process started? We don’t think so. German March headline inflation came in at 7.4% Year-on-Year, from 8.7% YoY in February. The HICP measure came in at 7.8% YoY, from 9.3% in February. The sharp drop in headline inflation is mainly the result of negative base effects from energy prices, which surged in March last year when the war in Ukraine started. Underlying inflationary pressures, however, remain high and the fact that the month-on-month change in headline inflation was clearly above historical averages for March, there are no reasons to cheer. 

No signs of broader disinflationary process, yet

Today’s sharp drop in headline inflation will support all those who have always been advocating that the inflation surge in the entire eurozone is mainly a long but transitory energy price shock. If you believe this argument, today’s drop in headline inflation is the start of a longer disinflationary trend. As much as we sympathised with this view one or two years ago, inflation has, in the meantime, also become a demand-side issue, which has spread across the entire economy. The pass-through of higher input prices, though cooling in recent months, is still in full swing. Widening profit margins and wage increases are also fueling underlying inflationary pressure, not only in Germany but in the entire eurozone.

Available German regional components suggest that core inflation remains high. While energy price inflation continued to come down and was even negative for heating oil and fuel, food price inflation continued to increase. Inflation in most other components remained broadly unchanged. Given that energy consumption is more sensitive to price changes than food consumption, it currently makes more sense for the European Central Bank to only look at headline inflation that excludes energy but includes food prices when assessing underlying inflationary pressure.

All this means is that just looking at the headline number is currently misleading; there are still few if any signs of any disinflationary process outside of energy and commodity prices.

Headline inflation to come down further but core will remain high

Looking ahead, let’s not forget that inflation data in Germany and many other European countries this year will be surrounded by more statistical noise than usual, making it harder for the ECB to take this data at face value. Government intervention and interference, whether that’s temporary or permanent or has taken place this year or last, will blur the picture. In Germany, for example, the Bundesbank estimated that energy price caps and cheap public transportation tickets will lower average German inflation by 1.5 percentage points this year. And there is more. Negative base effects from last year’s energy relief package for the summer months should automatically push up headline inflation between June and August.

Beyond that statistical noise, the German and European inflation outlook is highly affected by two opposing drivers. Lower-than-expected energy prices due to the warm winter weather could are likely to push down headline inflation faster than recent forecasts suggest. On the other hand, there is still significant pipeline pressure stemming from energy and commodity inflation pass-through and increasingly widening corporate profit margins and higher wages.

Even if the pass-through slows down, core inflation will remain stubbornly high this year.

ECB has entered final phase of tightening

As long as the current banking crisis remains contained, the ECB will stick to the widely communicated distinction between using interest rates in the fight against inflation and liquidity measures plus other tools to tackle any financial instability. The fact that there are still no signs of any disinflationary process, discounting energy and commodity prices, as well as the fact that inflation has increasingly become demand-driven, will keep the ECB in tightening mode.

The turmoil of the last few weeks has been a clear reminder for the ECB that hiking interest rates, and particularly the most aggressive tightening cycle since the start of monetary union, comes at a cost. In fact, with any further rate hike, the risk that something breaks increases. This is why we expect the ECB to tread more carefully in the coming months. In fact, the ECB has probably already entered the final phase of its tightening cycle. It’s a phase that will be characterised by a genuine meeting-by-meeting approach and a slowdown in the pace, size and number of any further rate hikes.

We’re sticking to our view that the ECB will hike twice more – by 25bp each before the summer – and then move to a longer wait-and-see stance.

source: ING

FED raised interest rates by 0.25%, now it’s the Bank of England’s turn

The Federal Reserve raised interest rates by 0.25%, much of which was priced in. But Federal Reserve Chairman Powell signaled that there would be another 0.25% hike before this contractionary cycle ends, which was a hawkish tone. but, there is not even a certainty that there will be another interest rate hike or not. because Fed policy no longer depends on inflation and all banking stress and crisis available too. As Powell put it, “adequate credit enhancement from bank problems” somehow “substitutes for rate hikes.”

And uncertainty about the credit crunch adds to the confusion about the Fed’s policy

Now it is the turn of Europe and England

After the Fed meeting and Powell’s speech, European Central Bank President Lagarde reiterated that the ECB will maintain a “strong” approach to responding to inflationary risks and that the 2% inflation target is non-negotiable.

This year we see a hawkish European Central Bank and a weakened American Central Bank. The easing of the US Federal Reserve and the hawkishness of the European Central Bank could have increased the expectations that EURUSD could continue its possible growth above the 1.10 range. The 1.1275 range is currently considered a logical target for buyers.

In the case of England, the high inflation shocked everyone and the new inflation report destroyed the predictions of Billy, the head of the Bank of England, that “we will see a sharp drop in inflation”.

Due to the fact that inflation will not decrease on its own, it is almost certain that the Bank of England will increase the interest rate by 0.25% in today’s meeting and we can see higher prices for all GBP pairs.

UK shopping inflation

UK inflation resurgence points to final 25bp rate hike this week

January’s dip in services inflation seems to have been a temporary one, and the bounce back in core CPI in February is unwelcome ahead of the Bank of England’s meeting this week. We expect a final 25bp hike on Thursday

A day before the Bank of England announces its latest decision, it is faced with an unwelcome resurgence in UK core inflation. Core CPI is back up at 6.2% (from 5.8% in January), and more importantly shows that the surprise dip in services CPI last month was a temporary one.

Policymakers have signaled this is an area they’re paying particular attention to, not least because service-sector inflation tends to be more ‘persistent’ (that is, trends tend to be more long-lasting than for goods) and less volatile. Inflation in hospitality is proving particularly sticky.

The caveat here is that the Bank has indicated it is paying less attention to any one single indicator, and is focused more on a broader definition of “inflation persistence” and price-setting behavior. And in general, the data has been encouraging over the past month or so. The Bank’s own Decision Maker Panel survey of businesses points to less aggressive price and wage rises in the pipeline, and the official wage data finally appears to be gradually easing.

We suspect the Bank will want to see more evidence before ending its rate hike cycle entirely, and that’s particularly true after these latest inflation numbers. We’re still narrowly expecting a 25bp hike on Thursday, and we think the BoE will take a leaf out of the European Central Bank’s book and reiterate that it has the tools available if needed to tackle financial stability, thereby allowing monetary policy to focus on inflation-fighting. This was the mantra it adopted last October/November during the mini-budget and LDI pensions fallout in UK markets.

However, assuming the broader inflation data continues to point to an easing in pipeline pressures, then we suspect the committee will be comfortable with pausing by the time of the next meeting in May.

source: ing


EUR roadmap for this week

The European Central Bank took a less hawkish approach to its interest rate hike cycle at its March meeting compared to its February meeting.
As a result, interest rate markets now expect the European Central Bank to not raise interest rates again.
Due to the hawkish policies of Europe, there will be a strong focus on future growth and inflation data. Because it will form the market’s expectations about whether the interest rate increase will be done or whether it can be implemented.
This means that the focus for the euro this week will be on Friday’s Manufacturing and Services PMI. But due to the inverse correlation of the euro with the US dollar index, the Fed’s policy decision on Wednesday could clear the way for euro traders.

Fed decision

Confusion to predict the decisions of the FED

The tension in the banking sector has led to a shift in the expectations of Federal Reserve interest rates. Markets have gone from pricing in a 100.0% increase in interest rates with no reduction this year to only a 17.0% increase with a 91.0% decrease this year.

This change caused a fall in the yield curve and pushed the price of the dollar down because the interest rate increase was out of the pricing.
However, the USD has been highly volatile due to risk sentiment flows and economic data
This creates a turbulent environment for the dollar at the moment, as the growing likelihood of recession and investment pressures should be a positive factor. But for now, if the Federal Reserve confirms in this week’s meeting that they will not raise interest rates again, this should be a negative factor for the US dollar.
On the eve of the Federal Reserve’s monetary policy decision on Wednesday this week, it is very complicated to know what the most likely reaction is from the US.

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