- Inflation expectations have played a role in the recent dramatic market moves…
- …however we expect oil prices to soften in the near term dampening inflation expectations
- Widening yield spread have supported EUR/USD for now
Recent dramatic moves in financial markets…
The recent sharp rise in bond yields in Europe and in the US has puzzled analysts across the globe. Explanations are ranging from profit taking, abandoning risk aversion trades, thin market conditions, lack of buyers and higher oil prices pushing up inflation expectations. There is probably not one single explanation.
…influenced partly by higher oil prices
Since the low set in January Brent oil prices have risen from USD 46.6 to 68.2 per barrel, or more than 46%. This is a significant move, but it is dwarfed compared to aggressive sell-off in the period July 2014 until January 2015. This recovery in oil prices has pushed up inflation expectations 5 years ahead in Europe (see graph) and in the US. In general, higher inflation expectations are positive for gold prices, which are often seen as an inflation hedge. However, this time around gold prices have been under pressure. Why is this? The rise in bond yields has outpaced the rise in inflation expectations. In short, real yields have moved higher and this is negative for gold. In general, higher yields (especially real yields) are negative for an asset like gold that yields zero or almost nothing. In the near term, we expect oil prices to decline, as markets will realise that supply is still ample. This will likely dampen inflation expectations going forward.
Widening yield spread supports EUR/USD
The more substantial increase in Bund yields compared to US Treasury yields and the improvement in investor sentiment towards the eurozone have given strong support to EUR/USD. It is likely that weaker-than-expected US data releases weighed on US Treasury yields as well as on the dollar. Strong US economic numbers ahead, starting with today’s US employment report, will most likely result in a more positive spread behaviour for the US dollar.
The Norges Banks keeps policy on holds…
Yesterday, the Norges bank left monetary policy rate unchanged at 1.25%. It stated that developments in the Norwegian economy have so far been broadly in line with March projections. The Norwegian krone strengthened after the decision as the likelihood for further easing is lower now.
…while the Czech central bank will continue to use the koruna as policy instrument
Meanwhile, the Czech central bank reiterated its intention to use the koruna exchange rate as an additional instrument for easing monetary policy conditions. The bank has already brought its policy rate to a technical zero, and relies on the exchange rate as an addition monetary policy tool. It confirmed its commitment to intervene on the FX market if needed to weaken the koruna so the exchange rate of the koruna is kept close to CZK 27 to the euro. It stands ready to intervene automatically. The Czech economy, as the Polish economy, will benefit from the upswing in the eurozone, its main trading partner, and an improvement in its labour market. This should underpin growth and help inflation to eventually pick up again.