Mizuho Daily – c-Core!

Mizuho daily market insights by Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

En-Core!

Soft core inflation in the US suggests that hopes for an encore Fed stimulus (extending well after a recovery takes shape in the headlines) are validated; as it pushes a wedge between reflationary (fiscal and monetary) policies and the inflation consequences. Oh, and the timing! Could not have been orchestrated better.

As Biden’s (albeit augmented by Senate) US$1.9 trillion fiscal stimulus plan was passed by the House, CPI data revealing softer sequential core pressures were there to greet and subdue fears of runaway inflation. Upshot being, US inflation data appears to have bought some space for, and lent credence to, prolonged and unwavering stimulus; but stops short of guaranteeing imminent Fed response at next week’s FOMC (apart from attention signals via “Dot Plot” and economic projections).

As such, UST yields have softened, but only modestly across the curve; except at the very long-end, where the impending 30Y auction has nudged up 30Y yield modestly. In turn, slightly softer yields amid prospects of “encore” stimulus have given some boost to equities (Dow up 1.5% at record highs above 32,000) and S&P500 up 0.6%. USD also eased back; but whether or not on encore bearish USD bets supplanting prospects of resurgence in real yields is debatable amid softer yields.

Against this backdrop, AUD has regained traction above 0.77; USD/JPY has slid to mid-108 and USD/SGD below mid-1.34. EUR has popped above 1.19 taking advantage of lower UST yields. But while the tension between reflationary pressures and inflationary risks has been alleviated, markets are somewhat tentative; as is evident in toe-dipping not plunge-in moves bond and FX.

This is in itself revealing of deference to unknowns around FOMC “encore” policy guidance and/or options. And perhaps the ECB will have to set the stage for “encore” policy calibrations in response to upside volatility in long-end yields ahead of next week’s FOMC.

ECB: Yielding to More Stimulus Signals?

Since end-2020, the ECB has deemed it fit to maintain policy stance and growth forecasts despite renewed wave of COVID-19 infections, following decisive measures in Dec 2020.

To recap, at its Dec meeting, the ECB;

i) upped PEPP (Pandemic Emergency Purchase Program) by €500 billion to €1.85 trillion, and;

ii) extended TLTRO program (to borrow up to 100bps below MLF) by a year to end-2022.

This time, the focus will be clarity on the ECB’s position on recent bond market volatility. Specifically, on whether a catalyst for further action as signals so far are mixed. For example, Executive Board member Schnabel thinks gradual increases in yields are not concerning insofar it reflects improving growth prospects.

But in contrast, Banque de France Governor Villeroy deems appropriate policy response to an unwarranted yield surge. Either way, heightened yield volatility clearly warrants attention; as alluded to by ECB chief Lagarde. In particular, what too much yield volatility entails vis-a-vis financial conditions. Our best guess: In assessing discomfort with yield volatility, the ECB will focus on three things.

• First, depth of yield pick-up.
• Second, speed of moves.
• Finally, any resultant divergence with EZ yields. The latter especially could triggers a policy response sooner.

Admittedly, a weaker EUR despite rising yields is of some consolation, but not a panacea. Also on watch, the ECB’s latest inflation projections that may shed light on how the central bank is inclined to tackle yield volatility; specifically whether this is via express B/S expansion.

Credit Source: Mizuho Bank Ltd