Today's Markets: Euro steady before ECB meeting

Rangebound: Stocks are in a drift phase as the recent rally runs out of steam and investors assess just how much they want to own risk. There is clearly not an overweening buy-the-dip mentality out there. European stocks were lower in early trade Thursday ahead of the European Central Bank meeting. The FTSE 100 traded down around half a percent at 7,560 and the DAX was off by about 0.7 per cent at 14,349 in early trade before extending losses as the Stoxx 600 dropped 1 per cent. US stock markets closed lower last night, with the S&P 500 dipping one percent as mortgage demand stateside plunged to a 22-year low. The decline ensures the broad market is holding well within its two-week range between around 4,070 and 4,200. Chart has a definite bullish and flaggy look about it, so could run up again but sticking to view that we are in longer-term bear market.

All eyes are on today’s ECB meeting. The central bank is expected to end net asset purchases this month (or very early next) and signal a rate hike in July. Only stubborn subordination to forward guidance prevents the ECB from hiking today. Inflation expectations, both consumer and market-based measures, are elevated and the hard data continues to show rising pressures. Expect a big upwards revision to inflation forecasts – key will be the outlook for 2024 for gauging how far the ECB might go with hikes. So far the ECB has consistently underestimated inflation and the risk for euro bulls is that this complacency persists even now.

Whilst it seems unlikely that the ECB will opt for a 50bps out the door, it cannot be ruled out at this stage. EURUSD was well bid last month after touching 1.03 and the market has been very willing to latch onto any hawkishness. Market pricing is for 130bps of hikes this year, which implies 50bps at one of the remaining four meetings. Therefore, unless Christine Lagarde does hint that 50bps is on the table in July or September, euro bulls could be disappointed by the outcome. Nevertheless, the drift sideways in EURUSD means the market is likely not overextended and the aforementioned willingness to take a hawkish interpretation may play out with a break higher for the euro.

My view is the inflation situation has deteriorated markedly, the ECB needs to get on the front foot as quickly as possible and it ought to be frontloading hikes this summer and looking to do QT. Lagarde stressed ‘gradualism’ recently and this would suggest there is no rush to do 50bps immediately. Confirmation that market pricing is about right ought to be euro positive. However, we should always be mindful for communication risks… Lagarde can be sketchy. She might say ‘50bps has not been discussed’ (euro lower).

Meanwhile, the ECB is fighting a war on another front: fragmentation risk. As it seeks to tighten monetary policy, it risks sending sovereign bond spreads wider. Ms Lagarde famously said at the start of her tenure that “we are not here to close spreads”, but the messaging is now subtler and reflective of the risks. Bond spreads are widening this year on the expectation that as the ECB ends asset purchases, some countries’ debt will be perceived as riskier than others. The spread between Italian 10yr bond yields and their German counterpart has risen to more than two percent, from around one percent at the start of the year. This poses problems for the ECB that are unique to it – in the absence of the financial repression of QE, national debt markets move at different speeds as some are perceived riskier than others. The ECB might commit to using additional new tools to ensure monetary policy is effectively transmitted to all members. In other words, signal it is ready to prop up debt markets in more vulnerable economies to stop a blow-out in spreads. The language will be subtle enough but strongly signal that it will seek to contain bond spreads even as it tightens policy. Whether or not there is an official signal at today’s meeting  is unclear, but I would expect some mention.

Elsewhere in FX, GBPUSD drifts lower this morning even as the market raises rate expectations for September. Despite the weakness this morning the cross continues to drift along the range of the last month, showing little real direction. USDJPY paused for breath just under 134 after setting a fresh 20-year high yesterday. 

Citi on US CPI inflation on Friday: "We expect another strong 0.5 per cent MoM increase in core CPI in May, with upside risks and a continued pick-up in services prices. A pick up in services inflation would be a further sign that too-tight labor markets are a key factor driving high inflation." 

Crude oil futures rose with WTI (July) sitting above $121 this morning after spiking towards $123 yesterday. GS says the structural deficit in the oil market remains unresolved and is even tighter. Supply remains inelastic to prices, with core-OPEC (higher) and exempt countries (lower) production shifts broadly offsetting... "negative global growth impulse remains insufficient to rebalance inventories at current prices. As a result, we believe oil prices need to rally further to normalise the unsustainably low levels of global inventories, as well as OPEC and refining space capacities.” The bank raised its average Brent forecast to $135, up $10 from last forecast. Trafigura forecasts that oil prices could climb to $150 this year. 

An explosion at a liquefied natural gas (LNG) plant in Texas sent natural gas prices plunging yesterday having earlier hit a fresh 14-year high at $9.66. This morning prices are down heavily from this level at $8.20, with the outage of the plant meaning reduce export bid for US nat gas. 

Musk things: Twitter (TWTR) is ready to give Elon Musk some of the raw data he wants to check for bots. He will get a stream of data consisting of 500 million tweets posted every day, the Washington Post reported. This stream, the so-called ‘firehose’ of data, is something that a small number of ad agencies get access to, but it does not comprise the full set of raw data, such as inactive but real accounts. Expect Musk to keep complaining about not getting what he’s asked for and suggest a breach of covenant in the deal by Twitter. 

Neil Wilson is the Chief Market Analyst at markets.com