European stocks took some comfort from China’s easing policy

Markets

Markets got off to a slow start to the trading week yesterday as American investors were absent due to Martin Luther King’s vacation. In other major developed markets, news flow was thin. European equities were somewhat reassured by China’s easing policy. European indices closed with gains of around 0.50 to 0.75%. The default trend in European interest rate markets also remains north even without guidance from across the Atlantic. German rates rose between 2.2 basis points (2 years) and 1.3 basis points (30 years). German 10-year yields again hit a high of 0.02% / the psychological barrier of 0.0%. The dollar rose slightly, with DXY closing at 95.26 and EUR/USD at 1.1408.

This morning the Bank of Japan left its policy unchanged but changed its assessment of inflation (see below). Still, any speculation about a change in policy is likely premature. Japanese yields are little changed. USD/JPY immediately after the decision moved from the 114.50 area to the 115 area, suggesting markets were positioned for a more hawkish stance. Outside of Japan, a sharp rise in US yields as trading resumes after the MLK holiday is attracting attention. Fed governors are no longer allowed to give guidance on policy as they are in the blackout period ahead of next week’s policy meeting. This does not prevent the markets from anticipating a bolder action from the Fed. The US 2-year yield jumps north of 1.0% (currently 1.05%), the highest since late February 2020. The 10-year yield tops the cycle peak by 1.80% (currently 1.84 %). Rising yields are leading to losses, albeit mostly modest, in Asian stock markets. China is the exception to the rule (CSI 300 +0.7%) as markets ponder the possibilities of another PBOC stimulus. Still, the yuan (USDNCY 6.3425) is holding its own after hitting a new cycle high overnight.

Later today, German ZEW Economic Sentiment should improve slightly from 29.9 to 32.0. In the United States, the Empire Manufacturing is expected to drop from 31.9 to 25, but this is still a high level. We don’t expect today’s data to change the policy normalization debate. The key question is whether US investors will join in the Asian bond sell-off. Markets are now pricing in four 25 basis point hikes from March and some investors are debating the chances of a 50 basis point hike at the start. The general trend could propel the German 10-year yield into positive territory. The other question is whether the dollar will benefit from the continued normalization of the market frontloading policy. At least this morning, the dollar’s gains are again modest even if the stock indexes point to losses at the European open. In the United Kingdom, labor market data this morning were close to expectations (3 months of employment in November weaker than expected at 60,000; the unemployment rate fell to 4.2% and wages rose by 4.2% as expected). In a first reaction, EUR/GBP remains in the 0.8355 area.

News headlines

The Bank of Japan has not changed the policy parameters which include buying bonds, a policy rate of -0.10% and a 10-year yield target of 0%. However, for the first time since 2014, it changed the inflation risk balance from mostly on the downside to balanced, meaning the BoJ sees equal risks for prices to breach the target. The move came after Reuters, citing sources, reported last week that the BoJ was debating how to start communicating on a possible rate hike, even if inflation remains below target. The latter is still the case in updated forecasts which, although raised, show inflation well below 2% (1.1% for the 2022 and 2023 financial years). Growth in FY21 (through April) has been revised down from 3.4% to 2.8%, but is estimated to be 3.8% in FY2022 (vs. 2.9%) on Omicron, which is delaying the recovery. The Japanese yen lost ground, with some investors perhaps expecting more given the Reuters report. USD/JPY is trading at 114.82.

During yesterday Eurogroup meeting, several finance ministers in the euro zone raised the issue of inflation (5% in December). They warned that this affected purchasing power and therefore economic growth. Eurogroup Chairman Donohoe at a press conference later said high inflation would indeed last longer than initially expected, but added he was confident price pressures would begin moderate later in the year as supply chains continue to improve and the effects of forced savings accumulation due to lockdowns begin to wane. The Eurogroup also discussed business vulnerability and structural changes after the pandemic, the draft recommendation on economic policy for 2022 and the banking union.

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