Interest Rate Divergence: How the US and Europe are Moving Apart

(KBC Market Research Desk)

Markets

US and European interest rate markets diverged further yesterday. German/EU yields didn’t see much spill-over from Tuesday’s sharp post-Powell repositioning in US markets. The German curve inverted further (2-y yield up 2.5 bps, 30-y minus 6.4 bps) in a session deprived of data. US yields initially corrected lower, but fortunes again changed in US dealings. ADP private job growth came in at a solid 242K. Higher than-expected JOLTS job openings, laid the groundwork for an intraday reversal in US yields. Fed Chair Powell in his hearing before the House stressed that no decision has been made on the magnitude of the March 22 rate hike as it remains conditional to the totality of incoming data, including tomorrow’s payrolls and next week’s February inflation. This ‘conditionality’ didn’t change the markets’ assessment that the bar will be high for the Fed not to return to a 50 bps step. The Beige book, preparing for the March 22 Fed meeting, showed (anecdotic) evidence that the US economy held up well at the start of the year. A $32bn 10-y auction only drew mediocre investor interest. In the end, US yields gained 6.2 bps (2-y) to 2.2 bps (30-y). The real 10-y yield also made another step higher (1.66%, +8.5 bps). Still, this hardly had any impact on equities (Dow +0.18%; Nasdaq +0.4%) or the dollar. DXY closed almost unchanged at 105.66. Similar conclusion for EUR/USD (close to 1.0545). Given additional interest rate support over the previous two sessions, this is slightly disappointing for USD bulls. EUR/GBP holds a tight range close to, mostly north of 0.89, but finished at the big figure.

Asian equities mostly show modest losses this morning with Japan outperforming. Chinese CPI inflation unexpectedly dropped from 1.9% Y/Y to 1%. PPI factory prices drifted further into negative territory (-1.4% Y/Y). The yuan eases marginally to USD/CNY 6.97. Later today, the eco calendar is very thin with only US jobless claims. ECB governors from today on will abstain from comments on monetary policy ahead of next week’s interest rate decision. We expect mainly technical trading ahead of tomorrow’s US payrolls. Some consolidation on the recent rally in yields is likely, but we see the downside well protected. Regarding the dollar, additional interest rates support apparently isn’t enough to attract strong buying interest as long as equity resilience mitigates safe haven demand. Apparently, a solid payroll report is needed for EUR/USD to go for a test of the EUR/USD 1.0484/61 support.

News and views

The Bank of Canada stood pat in March, keeping the policy rate at 4.50%. It’s the first time that no back-to-back hike occurred since the BoC started the tightening cycle in March last year. The decision was no surprise. In January, the BoC said it expected to keep rates stable after the hike back then, provided the economy evolved broadly in line with its outlook. Employment growth was surprisingly strong but growth in Q4 was slightly weaker than expected. The economic drag will last for several quarters, which should ease pressures in the labor market and moderate wage growth, the BoC said. Taking all the data into account, the central bank sticks to the idea that inflation (currently 5.9% headline, +- 5% core) is on track to hit 3% by the middle of this year. That said, the BoC keeps the option of further hikes on the table if necessary. The Canadian dollar underperformed global peers yesterday. USD/CAD closed above 1.38 for the first time since mid-October. Canadian yields tanked in a knee-jerk reaction before paring losses to some extent. They eventually closed 2.2 to 6.8 bps lower with the front end underperforming.

Poland’s central bank (NBP) stuck to a 6.75% policy rate, the rate applicable since September last year. Polish activity slowed down on the back of weakening consumption. Investment continued to increase though. The labor market remains strong, resulting in low unemployment. Inflation shot up in January to 17.2% y/y. In part due to a VAT reversal but also due to companies still being able to pass through higher input costs. That said, the NBP noted that the observed PPI decline together with weakening economic activity and the delivered monetary tightening will support a decline in domestic CPI inflation in coming quarters. This will be a gradual process, with the updated inflation forecast not showing a return to (the upper bound of the) target before 2025. Growth forecasts were marginally lifted across the policy horizon. The Polish zloty traded stoic in the wake of the decision. EUR/PLN closed a little lower, at 4.68, in a move that started earlier.

Read The Calm Before the Storm: EUR/USD Analysis Before US Jobs Report

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