Markets extend sell-off

• There were sharp moves in markets yesterday as they continued to absorb Friday’s inflation print from the US and the increasing likelihood of more aggressive action by the FOMC this week. Significantly, the S&P 500 dropped -3.9% yesterday, putting it down -21.3% ytd and into bear market territory.
• There was weak data out of the UK yesterday which has heightened the risk that the economy is headed for a recession amidst the cost-of-living crisis. GDP contracted for the second month in a row as it shrank by -0.3% m/m, missing Bloomberg consensus projections for a modest expansion of 0.1%. Services contracted -0.3%, and while much of this is attributable to a -5.6% contraction in human health and social work as Covid-related healthcare activity declined (GDP growth would have been modestly positive if not for this drag), there was also a decline in manufacturing (-1.0%) and construction (-0.4%), suggesting broad-based pressures on the economy. Firms are citing rising fuel and energy prices as impacting their businesses, according to the ONS. The Bank of England is due to meet on Thursday, and the latest data makes the (already outside) chance of a 50bps hike less probable, with another 25bps the most likely outcome.
• There is potentially more strife to come for the UK economy as Brexit tensions with the EU are flaring up once again. The British government has published a bill outlining its plan to override the Northern Ireland protocol agreement with the EU as it claims that it is unnecessarily hampering the movement of goods between Britain and Northern Ireland. The EU has threatened to take UK ministers to court over the move, and the risk of a trade war is heightening.
• CPI inflation in India came in at 7.0% in May, down from 7.8% in April and lower than consensus projections of 7.1%. The Indian government has implemented a number of measures in order to try and curb price growth, including subsidies on cooking gas and reducing fuel duty at the pump, while the RBI has also turned more aggressive with a 50bps hike last week.
• Turkey’s current account shortfall narrowed to -USD 2.74bn in April, compared with March’s -USD 5.79bn and less than the consensus -USD 3.20bn. A USD 933mn pickup in net tourism revenue helped offset the negative effect of higher energy costs on the trade in goods balance. Meanwhile, Turkish industrial production in April was flat on the previous month but up 10.8% y/y.

Key economic data and events today

08:30 Japan industrial production final reading, m/m, April. Forecast: -1.3%

10:00 UK ILO unemployment rate 3 months, April. Forecast: 3.6%

13:00 Germany ZEW survey expectations, June. Forecast: -26.8

13:00 Germany ZEW survey current situation, June. Forecast: -31.0

Fixed Income

• US Treasuries collapsed to start the trading week ahead of this week’s FOMC meeting. Markets are pricing a potential 75bps at some point over the next three meetings in the wake of the hot May CPI print and bond prices are having to adjust rapidly. Yields on the 2yr UST jumped almost 30bps overnight to close up at 3.3541% and are continuing to edge higher in early trade today. On the 10yr, yields added more than 20bps to settle at 3.3598% and the 2s10s curve has just narrowly moved into inverted territory.
• The rout in bond markets wasn’t limited to the US with European markets seeing liquidation as well. The prospect of tighter central bank policy generally and from the ECB specifically helped push yields on the 2yr Schatz up almost 18bps to 1.129% while the 10yr bund yield added 11bps to 1.626%. Italian spreads over German debt widened out to almost 240bps as a wave of risk-off sentiment crashed into markets. Markets in the UK also closed lower ahead of the Bank of England at the end of the week: yields on the 10yr bund rose 8bps to 2.526%.
• Emerging markets were caught up in the selling too with South African 10yr yields adding 23bps to 10.871% while emerging European bonds showed some heavy selling: yields on 10yr Polish bonds added 48bps to 7.609%.

FX

• The dollar was the only source of solace in the major liquidation of risk positions overnight. The broad DXY index rose by 0.9% to 105.078 as rising UST yields and the collapse of whatever risk sentiment may still be left in the market boosted the dollar. EURUSD fell by more than 1% to 1.0409 with a re-test of levels around 1.0350 the next likely target on the way down.
• The pressure in favour of the dollar was wideAspread. GBPUSD fell almost 1.5% to 1.2134 with open space on to the next technical test lower, the peak Covid low of around 1.14. The resurgence of Brexit debates as the UK prepares to unstitch part of the Northern Ireland deal it reached with the EU will also further threaten sentiment toward the UK and sterling. USDCHF moved against the franc, rising by almost 1% to 0.9976 while USDJPY held up fairly well, all things considered, staying at around 134.42 at the close.
• Commodity currencies showed some heavy selling with USDCAD up by 0.96% to 1.2899 while AUDUSD dumped by 1.9% to 0.6923 and NZDUSD fell by 1.56% to 0.6259.

Equities

• Asian equity markets followed their US counterparts lower on Monday morning, with the reimposition of restrictions on activity in Shanghai as the authorities grappled with Covid-19 cases further fueling risk-off sentiment. The Shanghai Composite closed down -0.9%, the Nikkei closed down -3.0%, and the Hang Seng ended the day -3.5% lower.
• There was no respite in Europe, where the FTSE 100 closed down -1.5% as GDP data disappointed. The FTSE 250, with greater exposure to the domestic market, lost -2.6%. Elsewhere in Europe, the DAX dropped -2.4% and the CAC -2.7%.
• In the US, the falls were even more significant as the S&P 500 lost -3.9% and fell into bear territory. The NASDAQ dropped -4.7% and the Dow Jones -2.8%.

Commodities

• Oil prices showed some volatile price action overnight with declines in the early part of the day overrun by the open of the US session. WTI closed up by 0.22% to USD 120.93/b while Brent futures added around the same amount to close at USD 122.27/b. US President Joe Biden is reportedly planning a trip to Saudi Arabia with expectation that easing some of the current tightness in oil markets high on the agenda.
• Production in Libya has collapsed again thanks to protests at major export ports in the country. Output is estimated at about 100k b/d compared with estimates of production at more than 1m b/d as recently as March.

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