Big core bond rally continued in the Euro area (German 10-year yield touching 0.35%), while EUR/USD continued to fall like a rock (to below 1.12). European equities rallied further (Stoxx 600 up by 1.74%), but US equities later fell. Oil prices have now been moving largely sideways for two weeks.
Greek election results gave the left-wing SYRIZA a strong mandate to push through major changes to the Greek adjustment programme, but not without having to form a coalition government. The ensuing negotiations will be tough and contribute to market volatility in the coming months, and could easily have clear consequences also outside of Greece. The return of Grexit fears remains a real risk, and would have bigger market consequences. Longer out, the Greek outlook continues to look uncertain.
On Friday, we changed a number of our key financial forecasts following the ECB’s convincing QE announcement. We now see EUR/USD at parity at the end of the forecast horizon and expect rates to rise much more gradually on both sides of the Atlantic, with German Bund yields reaching 1.0% at the end of the forecast horizon. We also havenew forecasts for JPY, GBP, CHF, NOK, TRY and US Treasury yields.
The Euro-area composite PMI rose more than expected to 52.2 in January, pointing to a continued recovery going into the new year. The bulk of replies are likely to have been gathered before the ECB’s QE announcement and hence we would expect a clear pick-up in the months ahead.
Day and week ahead
This week’s key event will be the FOMC meeting on Wednesday. We expect next week’s FOMC statement to indicate that the Fed remains on track to start raising rates around mid-year. From the US we also get Q4 GDP numbers and the Employment Cost Index (ECI) on Friday. On Friday, fresh inflation numbers from the Euro area will show even more negative headline inflation in January, but steady core inflation around 0.7%. In the Scandies we have retail sales and confidence indicators out of Sweden and retail sales out of Norway.
Today’s most important release will be the Ifo index, which is “old” information in the sense that it shows German sentiment before the ECB’s QE. We expect a rise in Ifo expectations to 103 in January from 101.1 in December.
Rates
The strong demand for bonds continued on Friday in the aftermath of the ECB decision and the yield on the German 10-year yield dropped 8 bp down to all-time lows (35 bp). The curve is now negative out to the second half in 2020 (compared to e.g. the Swiss curve, which trades negative out to 2028).
Peripheral bonds could not match the rally in core bonds, and e.g. the 10-year spread between Spain and Germany widened by 6 bp.
The development in the euro repo market should be watched closely from here. The ECB will enter the market as a large buyer during a year with limited German issuance. This is one of the reasons that may have caused the Bund spread to widen quite a bit versus for instance the Bobl spread.
The US Treasury yield fell in the early hours of trading, recovered somewhat before the European close but fell back after weaker- than-expected confidence and housing data in the afternoon. The 10-year yield finally ended the day down by 6.5bp, and has fallen some more early today.
FX
“The problem with QE is that it works in practice, but it doesn’t work in theory”. This quote from former Fed chief Ben Bernanke may help explain the tumultuous moves seen in the EUR over the past few weeks. While last week’s decision from the ECB will help prevent undue appreciation of the EUR, QE should now more or less be priced in, which is why focus turns to the Federal Reserve. The drop in oil prices and recent USD strength have contributed to a market that is leaning in the direction of the Fed softening and postponing its first rate hike from June to September or later. Signs that it will not be on Wednesday would underpin the USD further. Before that we may see some profit-taking.
SEK: The moves from the ECB have boosted speculation that the Riksbank will follow suit and either launch QE, cut rates to negative territory, or why not both? While we see distinct risks that the Riksbank may launch more easing, the krona is not yet a factor as it is 3% weaker than the Riksbank predicted in December. Use SEK weakness in the near term to position for a stronger krona down the road.
NOK: Oil prices are showing signs of stabilisation. This is NOK positive, and may help explain recent appreciation (on top of ECB QE). While the NOK would not normally start to appreciate before the easing cycle has ended (May), ECB QE is positive for the NOK.
Nordea