Rate differential no longer so favorable for euro

Rally could soon run out of steam

Chart of the Day

The euro has been on a tear recently, rising above $1.21 for the first time since early 2018. One reason why many have been optimistic on the euro is yield differentials moved sharply in its favor following the much larger interest rate cuts in the US at the start of the year. However, around half of the move in relative real 5yr/5yr differentials has been reversed in the past couple of months. While the relationship with yield differentials is far from perfect, this seems to suggest there’s limited upside for the euro ahead - especially if the ECB talks it down on Thursday.

Macro

One of the measures of UK house price inflation showed it roughly unchanged at 7.6% in November - realtors’ price expectations imply the market will soon soften again. There’s been similar calls in other countries of late, partly due to recent rebounds in bond yields.

Eurozone investor sentiment jumped this month following the recent vaccine news.

German industrial production has recovered to be down by 2.7% YoY, but the Ifo survey implies growth will remain negative.

Japan announced a further stimulus package yesterday. Even without further stimulus, the leading index bodes well for the recovery. That could be good news for local equities.

Markets

Gold and silver made strong starts to the week, perhaps because renewed US fiscal stimulus hopes are contributing to rising inflation expectations.

It’s iron ore that’s been the clear outperformer lately though, gaining a further 2% yesterday.

It has not been a strong story across the board, though - several commodities, including US natural gas prices, have dropped back in the past week.

And while US inflation expectations did jump last week, they too made a soft start to the week and dropped back by 5 bp. This is a key chart to watch at the moment, to see whether inflation expectations can continue to rise even as more states impose Covid restrictions again.

One thing that could lift inflation expectations would be further gains in commodity prices driven by elsewhere. China’s credit impulse shows credit growth is accelerating and implies commodity price growth will soon turn strongly positive.

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