By Thyagaraju Adinarayan
LONDON (Reuters) – The euro took a beating and German bond yields hit a fresh record low on Tuesday in reaction to European Central Bank President Mario Draghi’s comments indicating a possibility of new rate cuts or asset purchases.
Draghi said the ECB would need to ease policy again, if inflation did not head back to its targets, and that there was still “considerable headroom” to do so. Inflation in the euro zone slowed to 1.2% in May, the lowest in more than a year.
German government bond yields, the benchmark for Europe, fell to -0.30% for the first time ever and the euro slumped to a two-week low versus the dollar, while European stocks shook off early weaknesses to trade 0.9% higher.
“From the market reaction, we are increasingly learning that when a central bank’s senior leaders vindicate expectations, market shifts extend. The same thing happened when the Fed confirmed its dovish shift earlier this year,” said Themos Fiotakis, head of FX and rates strategy at UBS.
(Graphic: Draghi sends Bund yield to new record low – https://tmsnrt.rs/2XXH7Rc)
Draghi, nicknamed “Super Mario”, looks set to end his eight-year term this year without having ever executed a rate rise.
The ECB’s signals came a day ahead of a widely anticipated U.S. Federal Reserve policy decision, where expectations were running high that Draghi’s counterpart Jerome Powell would probably lay the groundwork for a rate cut later this year.
“In just a few months, the market has turned from being guided by the Fed to actively guiding the Fed,” interest rate strategists at Bank of America Merrill Lynch (NYSE:) wrote.
The U.S. central bank is likely to leave borrowing costs unchanged, but markets are almost fully pricing in a 25-basis-point rate cut for July.
The meeting will also provide the most direct insight yet into how deeply policymakers have been influenced by the U.S.-China trade war. [FED/DIARY]
Rate cut hopes, fueled by Draghi’s dovish speech, led the U.S. treasury yield to the lowest since September 2017.
Uncertainty over the trade war has sent investors storming toward U.S. Treasuries, a Bank of America Merrill Lynch’s fund manager survey showed. Treasuries were the “most crowded” trade for the first time in its survey.
(Graphic: U.S. interest rates – https://tmsnrt.rs/2Iogak7)
The impact of U.S. restrictions on exports to China is already resonating in Europe with German silicon wafer maker Siltronic warning that the spat would hit its sales and profitability.
The warning knocked European technology stocks, but a sharp reversal in the euro and rate cut signals offset the weakness driving the pan-European STOXX index 0.9% higher as of 1031 GMT.
In another blow to the German economy, which is expected to grow by just 0.5% in 2019, a survey by ZEW institute showed the mood among German investors deteriorated sharply in June due to recent weak economic data and the escalating U.S.-China trade dispute.
In Asia, MSCI’s broadest index of Asia-Pacific shares outside Japan edged up 0.6%, while Japan’s dipped 0.7%. MSCI’s gauge of stocks across the globe rose 0.15%, boosted by Europe.
“Markets have been very tentative over the last few sessions, trading largely sideways…Oil dropping and gold rising is also an ominous sign,” said John Woolfitt at Atlantic Markets.
slipped a further 0.8% on Tuesday on global growth worries, although losses were capped by tensions in the Middle East after last week’s tanker attacks. [O/R]
Acting U.S. Defense Secretary Patrick Shanahan announced on Monday the deployment of about 1,000 more troops to the Middle East for what he said were defensive purposes, citing concerns about a threat from Iran.
The , tracking the greenback against six major peers, is holding tight at two week highs.
The Australian dollar fell to a fresh five-month low of $0.6830 after minutes from the Reserve Bank of Australia’s June meeting showed policymakers thought it might have to ease again to push down unemployment and revive wages and inflation.
The central bank cut rates to a record low of 1.25% earlier this month to support the slowing economy.
Meanwhile, sterling steadied after hitting 5-1/2 month lows as traders waited for news on the contest for the leadership of the ruling Conservative party.
“The fact that Boris Johnson will most likely become the new prime minister hangs like a sword of Damocles over the trend of the pound. With this in mind, investors are currently rather reluctant to place too much trust in the currency,” said Marc-André Fongern, a strategist at MAF Global Forex in Frankfurt.
In the developing world, stocks were set to snap a four-day losing run on Tuesday, while emerging markets currencies edged firmer against the dollar as cautious optimism crept into markets ahead of the Fed meeting.