Market Views

GLOBAL CREDIT BULLETS | Monday, 12th September 2022

ECB Hawkish is not enough 
During last week’s monetary policy meeting, the ECB raised rates by 75bp and substantially raised their inflation forecasts, in line with what we expected.
The revision in inflation forecasts was driven by the rally in gas prices experienced in August. 2022 and 2023 inflation forecasts climbed to 8.1% and 5.5%, respectively, whilst growth forecasts were revised down to 3.1% in 2022 and 0.9% for 2023. All revised forecasts were in line with market consensus, with the exception of the 2023 inflation forecast, which came c.70bp higher than what market expects, suggesting a more hawkish tone for 2023.
The overall tone remained hawkish, with Lagarde giving signals for higher terminal rates, referring to market prices directly, effectively legitimizing a terminal rate which could increase up to 2.3%. However, during her press conference, Lagarde ruled out any bigger hikes for the coming months. We believe future rate hikes and the terminal rate are still subject to a lot of uncertainty, mainly driven by inflation volatility.
A hawkish ECB so far failed to reverse Euro weakness. The Euro will be reacting to the pricing of the next 2-3 meetings: this means that the ’75bp is not the norm’ message triggered a lower repricing of the Euro (which then came back when Lagarde hinted at the possibility of another bigger hike shorter term).
Overall, shallow hikes and negative real rates seem to be capping the Euro for now. A potential fix for the euro could come from a sudden move higher in real rates or something else, which would most likely come from the energy plan or fiscal measures aimed at protecting the economy from the energy fallback. In terms of rates, we believe this inability to move the Euro means more hikes to come.

EU Energy Plan – Signs of hope
On Friday EU energy ministers presented a roadmap for a pan-European energy plan. While details will still need to be ironed out, we see the cohesion and the commitment in the plan as substantial, and enough for markets to continue re-pricing the extent of the European recession. 
Ministers invited the Commission to adhere to the following measures by mid September:
a. Propose measures aimed at capping the revenues of inframarginal electricity producers with low costs of production and at introducing a solidarity contribution from fossil fuel companies to be used to mitigate the impact of high energy prices on customers.
b. Propose emergency and temporary intervention, including gas price cap. Specific measures in this regard should also help limiting the impact of high gas prices on EU electricity markets and energy prices for customers.
c. Present a proposal incentivizing coordinated electricity demand-reduction across the EU in order to relieve pressure on electricity generation and address energy scarcity and high energy prices.
d. Design emergency liquidity instruments that would ensure that market participants have at their disposal a sufficient collateral to meet margin calls and that would address increased volatility in futures markets, and consider reviewing relevant guidelines to integrate the rules on safeguards.

US inflation – Waiting for more drops
We expect this week’s headline inflation print to come at a slightly softer, negative, level on a month-on-month basis, driven by the lower energy prices in the US. Energy prices will be more of a drag in August compared to July, expected to decline by more than 6% from an already steep decline of 4.7% in July. On a month-on-month basis, we believe core inflation will remain in-line with last month’s print. Recent data points indicate rent inflation is likely to remain strongly elevated for some time, keeping the Fed on a steep tightening path
On a year-on-year basis, headline inflation is on track to fall to 8%, down 1.1 ppts from June’s 40-year high at 9.1%. On the other hand, due to base effects, core inflation is expected to be higher, reaching 6.1% YoY after 5.9% last month, suggesting peak core inflation is still yet to come. Core services inflation is expected to pick-up, more than offsetting a drop in core goods inflation driven by lower used car prices. We think shelter prices will be key to watch in this week’s print as it will give a signal as to the stickiness of inflation.
Overall, we think a potential easing of inflation driven by lower energy prices will not be enough to make the Fed turn more dovish. During speeches last week, Powell and other Fed members reiterated the party line on the fight to inflation and flagged the risk of stopping monetary tightening too early, leaving the door open for inflationary pressures to reemerge. 
Unless we see a big surprise in inflation data this week – which would need to come much weaker than expected, we expect the Fed will hike 75bp at its next FOMC meeting in September. Currently markets are pricing in a c.68bp hike for the next meeting, implying a policy rate of just higher than 3%. Year-end expectations are of a 3.82% policy rate level, 149bp higher than where we are today. Nevertheless, the second soft print in a row may continue to help some easing in long-end rates and remove pressure from credit markets.

Algebris Investments’ Global Credit Team

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