After rallying on the initial downturn in US rates, the loonie quickly reversed course as markets shifted to a risk-off tone following the sharp drop in the pound. Governor Bailey’s comments pointed to substantially higher yields in UK gilts this morning and sent Treasury yields back towards their recent highs on the day as traders attempted to adjust pre-emptively to the spill overs this will have in the global bond market. This weighed on US equities and thus the loonie, with USDCAD reversing course to close 0.13% higher on the day.
US Treasuries came back online yesterday after closing for Columbus day on Monday, and they had a lot to catching up to do. A failed attempt at breaking the 4% threshold by the US 10-year yield early in the morning set the tone for how the day would pan out, however, as the overall session was summarised by a moderation in US rates. It wasn’t until 3:30pm BST that downside in rates and thus the dollar started to become apparent in markets as another failed attempt by the 10-year to rally back to the 4% handle coincided with a moderation in shorter-dated Treasury yields. The 2-year yield fell simultaneously with the 10-year, driven by falling inflation-adjusted rates. While this may sound technical, it ultimately signalled that markets were becoming less hawkish on the Fed’s perceived terminal rate. This plateauing in the Fed’s implied peak rate was seen in the money market space too. Shortly after the adjustment in markets, data from the New York Fed confirmed the market’s priors as the 1-year consumer inflation expectation fell 0.3 percentage points to 5.4% – the lowest reading since September 2021. While this view wasn’t shared within the medium-term inflation expectations data, it highlighted that pressure on de-anchoring expectations from elevated spot inflation rates had cooled. Overall, the less hawkish outlook from the US rates market spurred risk assets towards the end of the US session, until a sudden drop in the pound reversed the broad USD downside and sent the DXY index back slightly higher on the day. Today, the US bond market will continue to sit in the driving seat for global markets, especially as the first batch of inflation data is released in the form of the producer price index ahead of the publication of the FOMC’s meeting minutes at 19:00 BST. Given recent commentary by Fed officials, the meeting minutes will be scoured for concerns over the financial stability risks of such an aggressive tightening cycle.
The single currency shed gains alongside the pound yesterday evening, although to a far lesser extent as it ultimately closed the session out flat on the day. The main focus yesterday in European markets was the re-widening in Italian BTP and German bund spreads as some cold water was poured over the optimism about joint debt issuance. Today, the focus largely remains on energy market developments as energy ministers are set to meet. According to Bloomberg, Germany and the Netherlands will put forward a multi-pronged approach to try and help bring down the cost of energy in the EU. The primary pillar of their plan is joint purchases of gas to stop the current bidding war that is taking place. With energy concerns still front and centre for most investors with European exposure, the headlines stemming from Prague are likely to produce flurries of market volatility. In the afternoon, focus will also shift to events in Washington as both ECB President Lagarde and Governing Council member Klaas Knot are set to speak at 14:30 and 16:00 BST, albeit it at different events.
Price action in the pound yesterday was largely stable, as the currency enjoyed a sustained rally over the course of the European trading session against the dollar in line with the broader G10 move. That was until late into the evening session, at which point Governor Bailey’s comments sent sterling hurtling lower to close out the day down 0.8%. Speaking at the International Institute of Finance in Washington, Governor Bailey told funds that have been caught up in the LDI car crash that they have “three days left now”, referring to the expiry date of the Bank’s emergency programme. The comments at the time startled investors, and with domestic UK markets closed, the pound was the only financial instrument available to project this dismay. However, the comments by Bailey weren’t anything new as yesterday’s market notice by the Bank also reaffirmed their intention of winding down the programme at the end of the week. In this sense, Governor Bailey’s comments can be viewed as him testing one of the three bowls of porridge. Unfortunately, Bailey didn’t read the notice left to him by the Pensions and Lifetime Savings Association yesterday, which stated most funds would prefer the BoE’s programme to be extended until after the budget on October 31st. The market reaction to Bailey’s comments shows that the porridge remains too hot to carry on eating, and has prompted speculation that the programme would in fact be extended. This speculation has been emboldened by an FT report this morning that states the BoE has been privately signalling to bankers that it could extend the programme. The report has clotted the bleed that was occurring in GBP, but whether this holds will ultimately be up to the bond vigilantes when the gilt market opens at 08:00 BST. Ultimately, we agree with this outlook and think the BoE Governor will have to wait for the porridge to cool down first, or as we stated in yesterday’s report, the pound will have to drop further to stabilise the investment climate in the UK. Following Bailey’s comments yesterday, speeches by Chief Economist Huw Pill at 12:35 BST and external MPC member Catherine Mann at 18:00 BST will be closely watched. Outside of the monetary policy turmoil, headline risk remains plentiful as PM Truss heads to the 1922 Committee hat in hand as she tries to squash the rebellion within her own party. Meanwhile, data out of the UK this morning showed the economy contracted by 0.3% MoM in August, increasing concerns over an imminent recession.