U.S. index futures point to a slightly higher open, as markets in both Europe and Asian fall. The EUR surges to one year highs as markets continue to reverberate from Draghi’s hawkish comments while yields rose around the globe following similar hawkish comments from Fed speakers on Tuesday.
Asian stocks closed softer overall with benchmark yields sharply higher following hawkish comment from Draghi and Yellen. The MSCI Asia Pacific Index fell 0.3 percent as declines in technology shares overshadowed gains in banks and raw-materials companies. Samsung Electronics Co., Taiwan Semiconductor and Tencent led the selloff with losses of at least 1.2 percent.
Australian 10-year yield jumps as much as nine basis points, their biggest rise since November; while CAD and AUD lead gains in broad-based dollar pullback. PBOC skipped open market operations for fourth day, and drained liquidity fro the market for the 6th day while strengthening the daily CNY fixing by most in almost four weeks; Shanghai Composite closed modestly in the red as Dalian iron ore ended near unchanged after yesterday’s torrid gains. Of note were comments by a PBOC adviser, who said he sees no further tightening in 2H monetary policy.
In the start of the overnight session, as usual eyes were on the yuan, which was on deck for its biggest two-day gain since June 1, with China’s central bank strengthening its daily fixing by the most in almost four weeks after an overnight drop in the dollar, and the PBOC strengthened its daily reference rate by 0.35% to 6.8053.The yuan continued to rise on speculation of central bank intervention, with the offshore currency up 0.2 percent after surging 0.6 percent Tuesday. As a reminder, on Tuesday the Yuan surged in afternoon trade amid talk of PBOC intervention. Speaking of the PBOC, the central bank drained a net 50 billion yuan in open-market operations, pulling funds from the financial system for the sixth day in a row.
The big action however continues to be the follow through from Draghi’s comments on Tuesday which unleashed a hawkish avalanche on Tuesday. As a reminder, Draghi said that “as the economy continues to recover, a constant policy stance will become accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments – not in order to tighten the policy stance, but to keep it broadly unchangedâ€. In other words if prices rise as the ECB expect in 2018 ECB policy will become more accommodative as inflation picks up. Draghi also added that “all the signs now point to a strengthening and broadening recovery in the Euro area†and that “deflationary forces have been replaced by reflationary onesâ€. The ECB President also cited that risks of “hysteresis effects†had diminished and that “now we can be confident that our policy is working and that those risks have abatedâ€. Draghi also suggested that political winds are now becoming tailwinds. As DB strategists called it, the speech seemed to mark a transition from the “whatever it takes†period to “it will take less†and a potential slow turning point in the direction of travel towards tighter policy. The final day of the Sintra ECB forum is today and a as reminder a policy panel between Draghi, the BoE’s Carney, BoJ’s Kuroda and BoC’s Poloz is due at 1.30pm BST which will be worth watching.
The market reaction to Draghi’s comments was violent with 10y Bund yields surged +12.5bps to close at 0.368% and back to the highest yield since May 24th. That was the weakest day for Bunds since August 25th 2015 or 22 months. Comparable OATs rose 13.7bps to 0.732% which matches the sell-off on November 10th last year when yields surged higher post Trump’s election victory. Prior to that you’d have to also go back to August 2015 to find as big a sell-off. It was a similar story in the periphery too with yields in Italy, Spain and Portugal up +16.7bps, +12.2bps and +13.3bps respectively. 10y Gilts also surged +7.9bps to 1.088% while the moves also weighed on US Treasuries with 10y yields darting up +6.8bps to 2.206%.
Fast forward to Wednesday when the euro touched a one-year high and government bond yields climbed as investors digested a series of hawkish messages from central banks. European stocks sank in early trading as the global selloff in technology companies spread, while German 10Y yields rose as high as 0.40%, nearly doubling in two days, as the curve steepened sharply.
The Euro rose to the highest level since last June’s Brexit vote and most bonds extended declines. The currency is now up almost 10% this year. The head of the Federal Reserve, Janet Yellen, and one of her lieutenants, Patrick Harker, said on Tuesday that they expected to continue raising U.S. interest rates, but it couldn’t rally the dollar.
That provoked the banking world’s single biggest cheerleader for a stronger dollar, Deutsche Bank, to declare the end of the greenback’s bull run which dates back to 2014.
“I do think the euro now has got quite significant momentum behind it and I think that will build towards the confirmation of some tapering announcement this year. So I would be long the euro on a tactical basis for the rest of the year,” JPMorgan Asset Management’s Global Market Strategist, David Stubb, said.
At the same time core European bonds are the significant area of vulnerability to better euro zone growth and to changes in ECB policy, he told Reuters. “If you are looking at a 10-year maturity and further out, it is a global bond market and the extremely low yields in core Europe stick out alongside Japan and Switzerland as the places that seem stretched in terms of valuation.”
Not helping the doves this morning was the latest M3 and loan growth data out of Europe, which rose again, with M3 up 5% Y/Y, while Loan Growth rose by 2.6% Y/Y, up from 2.4% the month before, and once again suggesting that Draghi risks falling behind the curve if he doesnt tighten soon.
Janet Yellen added to the hawkish momentum as she noted asset valuations look rich and signaled the U.S. economy can withstand higher interest rates, and Treasury yields rose again after the biggest increase since January. Speaking in London, Yellen made a reference to asset valuations being “somewhat rich†by some metrics contributing to a late leg lower for risk assets in the US. However, the big negative catalyst had taken place earlier when the news that the healthcare legislation vote was to be pushed back beyond July 4th hit. Senate majority leader McConnell reflecting what is almost certainly still a lack of votes and clear divisions within the party. That was seen as another blow to the Trump fiscal trade while away from that markets were also spooked by the news of a fresh global cyberattack which has spread and hit government and corporate systems alike.
And while Yellen qualified her assessment that asset valuations look high by some measures, the note of caution came just as markets were buffeted by a series of events, including an IMF cut to its U.S. growth forecast, Google suffering the biggest ever EU antitrust fine, a fresh blow to the Republican agenda in Washington and a global cyberattack.
