ECB highlighted divergence helped by economic data

EUR: A sense of caution prevails

The EUR/USD rate remains roughly unchanged in the aftermath of the ECB policy announcement with the statement a near carbon-copy of the statement in September. We released an FX Focus yesterday (here) after the announcement and there were no significant take-aways other than what did not happen. There was no discussion on changes to the minimum reserve policy or in regard to the current PEPP guidance that currently commits to full reinvestment of maturing securities through to the end of next year. There was also no explicit or even implicit criticism of Italy’s recent fiscal policy easing that put upward pressure on the BTP/Bund spread. The unwillingness of the ECB to address any of these issues could be an illustration of concerns over the health of the real economy and the reluctance to add to past tightening steps that were being “transmitted forcefully into financial conditions”.

There was certainly also an unwillingness on the part of President Lagarde to play up the extent of economic weakness – possibly out of fear of fuelling rate cut expectations prematurely. Lagarde described the PMI data as “not indicative of very vigorous growth” – which let’s be honest is a bit of an understatement. The Bank Lending Survey data was also mentioned as evidence of the transmission of monetary policy which was highlighted by the demand for loans from all enterprises over the coming three months falling to the lowest level since the GFC.

You certainly got the sense that the ECB was playing down the reality of the actions taken to date that will likely increase expectations over the prospect of the ECB being quicker to reverse course and ease its monetary stance. The strength of the US economy could be reinforcing the tightening of financial conditions given Lagarde also made the point that a key driver of higher sovereign yields in the euro-zone was due to the move in the UST bond market. If the data doesn’t turn weaker in the US the transmission of tighter ECB policy could become even more forceful.

We still do not expect that dynamic to play out for much longer and certainly by the time of the December meeting would expect to see lower UST bond yields as US economic data turns weaker. The Q3 real GDP data revealed a larger than expected expansion of 4.9% Q/Q SAAR driven by consumer spending of 4.0%. The key for the markets though was the breakdown of the data and what that breakdown means for growth going forward. That consumer spending growth contributed 2.69% of the total GDP growth, while inventories added a further 1.32ppts. there’s 4.0ppts of the 4.9% total growth. Government consumption provided a further 0.79ppts. Inventories could well take away from Q4 growth while consumer spending is set to slow notably.

The composition of GDP and the weaker core PCE inflation print (2.4% vs 2.5% expected) helped yields decline and limited the FX impact of the stronger than expected GDP print. The 10-year UST bond yield once again failed after reaching close to 5.00% yesterday and that has diminished demand for the dollar. EUR/USD resilience continues although risks of further dollar strength remain given the current divergence in economic performance.

ECB BLS INDICATES WEAKEST LOAN DEMAND SINCE GFC

Source: Bloomberg, Macrobond & MUFG GMR

USD: Middle East tensions rise

On the past two Fridays we have seen signs of investors’ appetite for reducing risk which likely reflected concerns over the possible escalation of the conflict in the Middle East. Today may see another similar pattern given there are already signs of tensions escalating after the US attacked  two Iran-linked facilities in Syria which the US described as “precision self-defence” strikes which were in response to increased attacks on US troops in the region. The US authorities were quick to differentiate these attacks from the Israel-Hamas conflict although the upturn in attacks on US troops in the region clearly coincides with the start of the Israel-Hamas conflict.

Iran’s foreign minister Hossein Amirabdollahian warned in a speech at the UN that the US would “not be spared” if the conflict in the Middle East escalates. The signs of rising tensions also coincided with increased episodes of Israel troops entering Gaza which will raise expectations of an escalation over the weekend. Crude oil prices are up close to 2.0% today and any escalation over the weekend will likely see further gains in the coming days.

Any de-risking into the close today and/or escalation over the weekend would put further downward pressure on yields assuming the energy price spike is not significant. For EUR natural gas prices are more important and for now remain stable after the initial jump immediately after the Hamas attack. It’s another downside risk for EUR/USD that could test the impressive resilience that has been evident of late. The drop in EUR/USD yesterday did see a break of a support trendline from the low earlier in October so the technical picture for EUR/USD continues to deteriorate.

SHORT-TERM IMPACT OF VARIOUS GEOPOLITICAL EVENTS ON BRENT

Source: Macrobond & Bloomberg

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
IT	09:00	Italian Business Confidence	Oct	96.0	96.4	!
IT	09:00	Italian Consumer Confidence	Oct	104.7	105.4	!
EC	11:00	EU Leaders Summit	--	--	--	!!
US	13:30	Core PCE Price Index (MoM)	Sep	0.3%	0.1%	!!!
US	13:30	Core PCE Price Index (YoY)	Sep	3.7%	3.9%	!!!
US	13:30	PCE Price index (YoY)	Sep	3.4%	3.5%	!!
US	13:30	PCE price index (MoM)	Sep	0.3%	0.4%	!!
US	13:30	Personal Income (MoM)	Sep	0.4%	0.4%	!
US	13:30	Personal Spending (MoM)	Sep	0.5%	0.4%	!!
US	13:30	Real Personal Consumption (MoM)	Sep	--	0.1%	!
CA	13:30	Wholesale Sales (MoM)	--	--	2.3%	!!
US	14:00	Fed Vice Chair for Supervision Barr Speaks	--	--	--	!
US	15:00	Michigan 1-Year Inflation Expectations	Oct	3.8%	3.2%	!!
US	15:00	Michigan 5-Year Inflation Expectations	Oct	3.0%	2.8%	!!
US	15:00	Michigan Consumer Expectations	Oct	60.7	66.0	!!
US	15:00	Michigan Consumer Sentiment	Oct	63.0	68.1	!!
US	15:00	Michigan Current Conditions	Oct	66.7	71.4	!
CA	16:00	Budget Balance	Aug	--	-4.86B	!
CA	16:00	Budget Balance (YoY)	Aug	--	-1.24B	!

Source: Bloomberg