Looking for the peak

Last Thursday, the European Central Bank decided, as expected, to end its bond purchases as of 1 July. Ending the fiscal stimulus was a prerequisite for the upcoming rate hikes. There is now little doubt that on 21 July and 8 September the ECB will raise its benchmark rate twice from its current level of -0.50%. Christine Lagarde has suggested that it could be brought up to zero or slightly above by the end of the third quarter. Yesterday, the president of the Dutch central bank said that the ECB has several options and suggested that rates could be at 1% by the end of the year. These announcements did not surprise anyone and did not push the euro up: on the contrary, it fell back. This is because, in parallel with the surge in eurozone yields, a “fragmentation” phenomenon is frightening the markets. Specifically, the premiums that investors demand to hold bonds from the weakest countries in the bloc have reached their highest level since 2020. The yield spread between Italy and Germany for 10-year bonds, which stood at 135 basis points at the beginning of the year, is now 235 basis points. The same phenomenon can be observed with Portugal and Spain to a lesser extent. Spreads haven’t been so big since the beginnings of the COVID crisis, which pushed the ECB to act and set up its pandemic emergency purchase programme (PEPP). Fragmentation, which is seen as an indicator of financial risk in the euro area, has logically weighed on the single currency. The fall of the euro and the rise of the dollar accelerated the next day, Friday 10, with the shocking release of the US inflation figures. While many investors were hoping to see the beginning of a plateau or even a peak in inflation, the consumer price index exceeded expectations – again – by accelerating again. Inflation rose by +1% month-on-month in May after +0.3% in April. On an annual basis, prices rose by +8.6% compared to +8.3% the previous month. Now the market expects the Fed to raise rates even more aggressively, potentially with 75bp hikes in June (decision expected tomorrow) and July, and a third 50bp hike in September. The prospect of a rapid rise in interest rates has plunged the market into a climate of risk aversion. Both equity and bond markets have seen a massive sell-off. The S&P 500 index has officially entered a bear market (down more than 20% since 3 January) while the Nasdaq has lost almost a third of its value.

Cryptocurrencies are also under pressure: Bitcoin plunged to a low of $20,800, bringing the entire market down with it. Already battered by inflation, crypto has also been rocked by the decision of a cryptocurrency lending platform to suspend withdrawals by its customers. For this company, this could mean a liquidity crisis caused by the bear market. And so, investor confidence has taken another hit, not long after the Terra stablecoin scandal – which was not so stable after all.

The yield on 10-year US Treasuries, which moves in the opposite direction to its price, soared to 3.49% yesterday: the first time this has happened in over 11 years. At the beginning of the week, the yield curve inverted, with the 2-year US Treasury yield briefly rising above that of the 10-year notes. Such a reversal is often interpreted as a harbinger of recession. The dollar continued its advance against the major currencies and particularly against the yen with a 24 year high (!) at 135.50 last night. The yen had briefly rallied on Friday evening when the Japanese government and central bank expressed concern about the plummeting currency. It was a rare statement seen as the strongest warning yet that Tokyo might intervene to support the yen. Gold is also suffering from the rise of the greenback and has lost 50 dollars over the week. And against the Swiss franc, the dollar briefly rose above parity yesterday. This morning one dollar was worth CHF 0.9990.

In Switzerland, the yield on the 10-year Swiss government bond is also up sharply and now stands at 1.4%, up from 0% at the beginning of the year. The SNB will meet tomorrow to decide on its monetary policy. Switzerland will probably not raise rates tomorrow but may do so from September. If it does, the SNB will move in lockstep with the ECB. As a reminder, inflation in Switzerland, even if it is at a 14 year high, remains much lower than elsewhere at 2.9% in annualised terms in May. For the past two days, the EUR/CHF has rebounded above 1.035, although it has not crossed the 1.050 mark. This morning it traded at 1.0477.