G3 Recap 1-13-11

Main Items:

  • US Initial Jobless Claims jumped to 445k last week vs 410k expected and 409k previously. The usual caveats around holiday weeks apply.
  • US Core PPI rose 1.3% YoY in Dec vs 1.4% expected and 1.2% previously.
  • The Spanish auction saw good bids. Bid to Cover was 2.1 times vs 1.6 at the Nov 4th auction.
  • Bernanke said in a CNBC interview “We think that a 3 to 4 percent-type of growth number for 2011 seems reasonable.” He also noted that “… you’re not going to reduce unemployment at the pace that we’d like it to.”

Overseas Data:

  • BoE and ECB kept policy unchanged as expected. However, Trichet was a bit hawkish, saying that "Risks to the medium-term outlook for price developments are still broadly balanced but could move to the upside". In the Q&A, he said “This is higher than expected and largely reflects energy prices. Looking ahead, we consider that inflation rates could temporarily increase further and be over and above the 2% level, before going back to what we consider price stability towards the end of the year […]this is the present judgment.”
  • Australian Employment declined to 5.0% in Dec vs 5.1% expected and 5.2% previously. This was due to a drop in the participation rate to 65.8% from 66.1% previously.
  • South Korea hiked 25bps to 2.75% vs market expectations of no changed. The government issued a package of steps (inc. a freeze on public-service charges such as for electricity and gas) aimed at checking rising consumer prices
  • UK IP rose 3.3% YoY in Nov as expected and unchanged prior previously.

Commentary:

  • Trichet’s comments today surprised the market and caused 2yr Schatz yields to gap up to range highs:

    Model regressions suggest that the belly of the European yield curve can reprice higher in the coming months on the back of strong core macro data, although it no longer looks so juicy:

    Current 5yr EUR swap yields are consistent with an ECB on hold through June 2012, and then hiking 25bps every 2.5 meetings after that, terminating at 4.5%. (This was roughly the pace of hikes over the last hiking cycle) Judging by Trichet’s comments today, it appears the ECB is assuming that oil prices do not continue to rally, thereby allowing headline EU inflation to fall toward core inflation levels. As we saw in 2007 and 2008, this is a dangerous assumption to make, and a further rally in the commodity complex is likely to engender more hawkish noises. This suggests further upside risk for 5yr EU yields.
    However, we should note that the same can not be said of the 2yr sector. By my calculations, 2yr EUR swaps are roughly consistent with ECB hikes starting in November of this year. (Again assuming the ECB hikes every 2.5 meetings) While this is certainly possible, the overhang of the PIIGS solvency issues suggest that the ECB is more likely to delay hikes, but then accelerate the pace of hiking once they do start.
    (NB: the chart shows Bobl yields, but I used swaps yields to compare against the path of ECB policy given that the EONIA futures market has no volume. I also assumed that 3m Euribor averages 20bps above the ECB refi rate)

  • Over the past year, US Financials have tended to make short term peaks around the start of earnings season. The chart below is of XLF with JPM’s earnings dates marked.

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