A hawkish ECB and 10-year US Treasury yield near 5%

0:00Good morning everyone and welcome to Julia's Bears Moving Market Podcast. It is Friday the 11th of September and my name is Lucia Czciuliewicz. I am your host today. As always there is a lot happening in the markets so first of I am joined by Mike Glaubo who will take us through the key developments and the main takeaways for investors. We will then be joined by David Cole or Chief Economist and we will delve deeper into yesterday's ECB decision as well as to what we expect from the Fed next week. But first Mike, good morning. It's great to have you with us. Thank you very much for having me. Good morning Lucia. So let's start with the big picture. US Treasury yields are hitting multi-year highs. The 10-year yield reached 4.95% which sounds significant.

1:00Can you tell us what's fueling this upward trajectory? Persistent inflation concerns in short. Middle East tensions, push-bred, crude past $107 per barrel and August producer prices in the US rose 0.4%. So that's up from 0.1% a month earlier. Governments are now heavily betting the Federal Reserve will raise interest rates next week and fully expect another increase by October. Adding another layer, the US Treasury $6 billion long dated bond buy back disappointed investors who were expecting a larger operation of up to $8 billion so that added to upside pressure on long-term Treasury yields. So we're really adding closer to that 5% mark on the 10-year yield. And some analysts suggest that's a crucial threshold. What implications does breaching that level have? Indeed, a move beyond 5% could represent a growing hurdle for financial market.

2:02It definitely presents a challenge for the US Treasury Secretary Scott Besson who has struggled to steam a cell of in bonds ahead of midterm elections in less than two months. And this higher yield translates directly into real economic impact. Data released yesterday showed home sales falling to a one-year low as rising mortgage rates dampened buyer enthusiasm. And Mike, those rising yields clearly ripple through other asset classes, precious metals to go ahead and US equities also soften. Can you tell us more? Exactly. So gold declined 1.6% still very even more dropping 5%. As for equities, all three major indices in the US close lower, though it wasn't a complete route. S&P 500 and NAS that composite both shed around 0.6, 0.7%. Interestingly, defensive consumer stocks proved relatively resilient and Apple bucked the trend gaining over 3% following the release of its new foldable smartphone.

3:02Speaking of corporate news, Mike, Oracle's after-hours earnings report garnered a lot of attention given the focus on AI. What stood out? Quite simply, the company delivered a strong quarter with a 30% jump in revenue fueled by doubling cloud infrastructure performance. The stock rallied 5% in either of the hours trading, confirming the positive outlook for AI investments in general. On that topic, Microsoft said it will triple data center capacity to 38 tigawaltz. Looking up in Google, it says this equals the power production of 38 nuclear reactors. It's impressive. AI continues to be dominant narrative. The ECB also weighed in, correct? Precisely. President Christian Lugard emphasized AI's growing impact on the European economy, particularly exports mirroring US trends. AI isn't merely a technological shift. It's a genuine economic growth driver. So coming back to the European Central Bank, it raised its deposit rate by 25 basis points

4:08to 2.5%. What's the story there? That wasn't dissipated, but the ECB also raised its growth and inflation forecasts. And so markets are now pricing in three right times by October 2027. European bond yields followed the US trend. For example, German two-year yields jumped to 3.23%, a multi-year high, and a 40 basis points increase in under three weeks, demonstrating substantial market repricing. Now against this backdrop, the Eurostocks 50 dropped 0.6%. And like the US this week, it has been trending lower. It's sitting at a two-month low, actually. Were there any stand-up performance or under-performance in the European space? So higher rates helped insurance and banks holding up relatively well. When we look at the corporate space Swiss company Novartis wasn't focused. It shares are down 13% this week after experiencing setbacks in three pivotal clinical trials.

5:11Now this is prompting calls for a board shake-up from a major shareholder, Artisan Partners. The shares were up a little less than half a percent yesterday. Looking at overnight market action, Asia appears to be mirroring the global downturn. Is that a fair assessment? Yes, the MSCI Asia Pacific index tumbled nearly 2%. It's biggest fall in three weeks. Eastern government bonds followed US Treasury's downward. And Australia's three-year yield hit an 11-year high. But we're seeing some stabilization, gold and silver slightly up. US equity futures too, and oil is below $105 a barrel when it last looked. Looking ahead, what's on the horizon for today? What key events will likely dominate market attention? Plenty of economic releases, but really the US consumer inflation report will be front and center. It will heavily influence expectations for the upcoming Fed meeting and shape investor sentiment either way.

6:12Anything else to end with? Yeah, you know, today marks the 25th anniversary of 9-11. Now, reflecting on history, the S&P 500 has demonstrated incredible resilience. Since reopening after 9-11, the Dow Jones industrial average has risen 944% including dividends. The testament to not only the rewards of long-term investing, but also when uncertainty is greatest. Very interesting. Thank you very much for this nice overview, Mike. Thank you very much for having me, Lucia. Let's now turn to central banks. Good morning, David. Good morning, Lucia. So David, the ECB delivered the expected rate hike, but the bigger story seemed to be higher inflation forecasts and a more up-beat growth outlook. What was your main takeaway from the meeting and Christine Lagarde's comments? Well, you exactly hit the point. So it was not only that they hike rates, but probably they delivered at least also on another notion

7:16that they did not recommit or shared any views where rates need to go after this meeting. So probably the focus shifted very much on what was updated, and let's focus on growth and inflation and you correctly outlined the growth had been ticked up. It's not huge growth upside revisions, but they did. But they rightly acknowledged that growth is quite resilient in this environment, which is definitely a surprise. On the inflation side, that's a very interesting story, what they delivered on the ECB and Christine Lagarde outlined that on detail in their press conference, saying basically the inflation forecast we did in the last meeting in June, sure term, it turned out more benign. So that's actually good news, and you would think, okay, then inflation goes down. At the same time, ECB staff thought that yes, inflation is not coming now,

8:16but we forecast that inflation elevated price levels will stay with us for longer, and also inflation will accelerate actually from this point. So that was the resupprise, not only for markets, but in particular also for us, which share the task to do inflation forecast, and did indeed surprise us because I think yes, we can talk about oil prices, energy prices, which are definitely not coming down. But we see little signs that we surpass the peaks we have seen earlier this year, and that's a bit of surprise. We still struggle a bit to square the inflation forecast, which what's happening on the ground. At the same time, yes, you can, as a central bank, which has a mandate for press stability, definitely a strong focus on the risk that there are upside risk on inflation, that there are second round effects, that there are indirect effects of energy prices on the

9:19rest of the price spectrum or price basket. And this is exactly what the ECB did. So consequently, markets were pricing in more archives. We as both of other economists and observers, which look at fundamentals are quite skeptical in particularly when it comes to 2027, but it was in summary. We have to say a high-purchase in expected, and a very focused message going forward. All right, and turning to the US and the inflation picture there, yesterday's PPI data broadly met expectations, though it came in higher than for July. What does it tell us about the inflation there, and what will you be watching most closely in today's CPI report? Yeah, on the US, as you outlined. So here for a change, the Fed is also extremely focused on the inflation. We have to just highlight that to the Fed has both a mandate for full employment and

10:20inflation. They put the mandate for full employment aside, and rightly so, because the US is probably very much at the point of full employment. So the focus is very much on inflation. Usually, the air preferred measure is the PCE-Depraeter, which comes later months, so ahead of the FOMC meeting, it's really the inflation, which helps to get a pretty good feeling what the PCE-Depraeter will be together with the producer process, which had been released yesterday. And here, the first step was getting a very current, a very up-to-date picture of inflation, was rather a disappointment. And we ourselves, we think that any rate hike is pretty much certain when inflation does not deliver some relief in terms of that this momentum is slowing, that we see a clear science of peaking, and that's why we're looking basically on the sequential

11:21dynamics, which are here. What we know already, and this is the difficult or the challenge, we know already that energy prices had been higher in August than in July. So from the headline number, we'll definitely see some upside pressure. The headline number will be not the one which delivers some relief, it's definitely the figure which is supportive for all the colleagues or market participants, which are betting on a rate hike. Interesting will be the underlying inflation momentum, which is more visible in the co-inflation rate, which includes energy, which excludes food. So simply because these components tend to be very volatile, tend to be not influenced by the cyclical dynamics. And here, we think we have still good chances that we will see here be nine number, that means that underlying inflation is slowing,

12:22that we have peaked here. When this is delivered, we stick to our focus, that the fact is in a good position to talk, to focus and to act, rubbish, or to refrain from rate hikes. When this data point does not deliver on the segmentations, then the fact has cornered itself, but into the rate hike, the promise of Kevin Worsh to say we are very much focused on inflation, and when inflation is so high, we need to act, and classically we need to act on interest rate hikes, then the conclusion is pretty clear. So it's a decided moment at 2.30 today. All right, and now specifically looking at next week's Fed meeting, markets seem quite divided on what's happening. What are you expecting from the Fed? So Lucia, as outlined, we think our baseline is still that the Fed can refrain from

13:23hiking ways. Why? Well, because most of the inflation push we have seen Shilpa is driven by energy prices, and that we see very little signs that this higher energy price is not translating in a broader inflationary trend, unlike in the 2022, when this has happened, and so from this, we still assume, as a baseline, that the Fed will stay put, that they will reap rates where they are, say that they are watching the situation evolving. At the same time, we think the Fed, and in particular, Fed Chair Worsh has put the Fed in a position that when some special inflation data points are not delivering on the notion that their clear signs, that inflation has rolled over, that inflation is moving closer to 2%, in particularly the underlying trends, then we need to act. And from this perspective, we attach to our, like, the confidence to our focus is quite

14:27limited, that they will stay on the put, and we are prepared that they will hike rates from here, simply to become more credible on their inflation-fighting attitude. So we wait basically until the inflation print until pinpoint down our focus, and so far market pricing after this PPI report, at least the last time I looked at, was 17 in favor of a rate hike, and 30 to stay unchanged. Great, very interesting. Thanks a lot for being with us this morning, David. I think you'll see how. So that is all for today, Dan. Thanks again to my guests, and thank you all for tuning in. Please join us again on Monday when we will be back with more news moving the markets. Until then, have a great weekend, everyone, and bye for now. The information and opinions expressed in this podcast constitute marketing material,

15:31and are not the result of independent financial or investment research. Please refer to www.dueliusbarr.com forward slash legal forward slash podcasts for further other important legal information.