Bank of England fails to convince markets

• The Bank of England raised rates by 25bps at its May MPC meeting, taking the Bank Rate to 1%. The vote was split, with six members in favour of the hike and three wanting a larger 50bps hike. The BoE put off a decision on drawing down its balance sheet, however, until later in the year which comes somewhat at odds with market expectations that the bank would undertake ‘active’ quantitative tightening via actually selling gilts from its balance sheet. The bank also seemed to soft-pedal expectations for further hikes and also projected an outright contraction in the UK economy next year and much slower growth in 2024. At the same time the BoE warned that inflation could peak above 10% by October this year. Markets generally took the moves as less assured and in some ways dovish and there was a sharp sell-off in sterling overnight.
• Inflation in Turkey rose by 69.97% year on year in April, higher than market expectations, and were up 7.25% month/month. Core prices were also up strongly, by more than 52% compared with 48% a month earlier. Producer price inflation for the same month rose to 121.82% y/y against around 115% a month earlier, suggesting that more inflationary pressure is in the pipeline as Turkey endures the impact of tight energy and agricultural commodity markets as well as wide negative real rates.
• The composite PMI for India rose to 57.6 in April, up from 54.3 in March. That represented the highest headline level since November last year. The services component rose to 57.9, up from less than 54 a month earlier even as India is digesting the impact of higher global commodity prices, both in energy and agriculture markets. The manufacturing PMI was released earlier in the week and was roughly stable but still comfortably in expansion territory at 54.7. Inflation pressures will be an acute threat to India’s economy this year and were the rationale for the RBI to move with an out-of-meeting hike of 40bps to policy rates earlier this week.
• Manufacturing activity in Germany fell sharply in March, down 4.7% month/month. The slump was far larger than had been expected and reflects disruptions to global supply chains and the lack of access to the Russian market, a key export destination for German firms. EU proposals to increasingly restrict their reliance on flows of Russian energy, whether natural gas or oil, will be a headwind on growth this year as alternative sources of energy will take time to be introduced into Germany’s economy.
• OPEC+ agreed to another monthly production increase of 432k b/d for June volumes at their meeting overnight. Production policy from the group of exporters is essentially on auto-pilot as members don’t want to risk overwhelming oil markets with supply even as there are material supply risks around Russia’s oil output. Even as they have announced another greater than 400k b/d target increase, the odds are that OPEC+ will fail to hit that level as some members run up against production capacity constraints: market surveys show the OPEC members of the alliance added just 10k b/d in April compared with a target level of 274k b/d.

Today’s Economic Data and Events

• 16:30 CA Net change in employment April: forecast 40k
• 16:30 US Unemployment rate April: 3.5%
• 16:30 US Non-farm payrolls April: forecast 390k

Fixed Income

• US Treasury markets fell sharply overnight in line with a broader “sell-everything” move following the Fed earlier in the week. Yields on the 2yr UST added 6bps to 2.7034% while the 10yr yield rose more than 10bps to 3.0365%. Inflation protected yields have been positive for the whole week with the 10yr TIPS yield at nearly 0.2%.
• Gilts oscillated sharply following the Bank of England’s decision to raise rates by 25bps which looks to have been taken as largely dovish by the market. The 10yr gilt ultimately closed near unchanged on the day with the yield holding at around 1.96%. Across the rest of Europe bond markets were weaker with 10yr bund yields adding 7bps to 1.041%.

FX

• Sterling crumbled overnight as markets took the Bank of England’s 25bps hike as far less aggressive than what is need to address inflation and in the context of the BoE putting off a decision on normalizing the balance sheet. GBPUSD fell 2% to 1.2362 as part of a broad sell-off across nearly all markets. EURUSD dropped 0.75% overnight to 1.0542 while USDJPY pushed higher once again, up 0.86% to 130.20.
• In commodity currencies USDCAD was the least worst, rising by 0.68% to 1.2834. AUDUSD fell more than 2% to 0.7112 while NZDUSD dropped 1.7% to 0.6430.

Equities

• It was a brutal day in global equity markets overnight with US indices plummeting lower. The Dow was off by more than 3% overnight while the S&P 500 fell 3.6% and the NASDAQ closed down nearly 5%. European markets were pushing lower ahead of the US open and may catch up with that move later today. The DAX dropped 0.5% and the CAC fell 0.4%. The FTSE was the one gainer, up 0.13% largely in response to a weaker pound.
• Asian markets have opened in the red today follow the sell-off in the US. The Nikkei is down modestly while the Hang Seng and Shanghai composite are both off sharply.

Commodities

• Oil prices were modestly higher overnight, one of the few asset classes to show any positive moves. Brent futures closed at USD 110.90/b, up almost 0.7% while WTI futures rallied 0.4% to USD 108.26/b. The market had largely been expecting OPEC+ to carry on with its modest production increases and a bid will remain under oil until there is greater clarity on the EU’s proposal to ban Russian oil.
• Gold prices fell overnight, failing to provide much haven relief as UST yields push higher, in both real and nominal terms. Across the rest of the precious metals space silver fell 2% while palladium was down more than 3%. In industrial metals moves were relatively contained with copper prices holding roughly steady at around USD 9,500/tonne and aluminium down modestly.

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