If yesterday was about bending, today is about the snap back fear. Rates up, equities down, USD up, commodities down – asset allocation and correlations will be driving investor decisions and the risk-party is looking for the punch bowl of liquidity. The best Services ISM ion record and FOMC Powell led US bond yields sharply higher to break out of their May highs and overnight continued to sell US bonds to 2011 levels over 3.20% in 10Y. Powell sees US monetary policy moving from neutral to restrictive in a gradual fashion – putting Fed Funds 3.25-3.75% range a real possibility in the 12-24 month horizon, something for the market to price. This has led to a stronger USD and hasn’t yet driven down equities, though global borrowers are on watch as higher US real growth means higher global rates. The US yield curve steepening maybe more a reflection of this reflexivity as bond yields in UK, Germany and Japan jump higher unwinding a term-premium demand for US paper. The snap back risk in rates upsetting the risk-parity party is clearly front and center but one that has notable limits from politics. The lack of China news this week stands out. The dampening effect of tariffs on confidence isn’t in play but it maybe later. Here are the key headlines that mattered in politics and policy beyond Powell overnight: 

  • UK proposal on Irish border “step in right direction,” according to the EU. The UK May plan to rush any deal through parliament added to view that Brexit talks part 2 are working. 
  • Vice President Pence tells China the US won’t be intimidated in the South China Sea. CNN reports the US Navy proposes a major show of forece to warn China. 
  • Italian government agrees on deficit to GDP targets of 2.4% in 2019, 21% in 2020 and 1.8% in 2021. A full budget is yet to be unveiled but will still be reviewed by the EU Commission which still can reject it. The Italian parliament will also have to approve it by the end of the year. 
  • ECB’s Olli Rehn reiterated that ECB’s role is “not to support the Italian bond market after its recent sell-off but to set policy for the whole of the Eurozone.” Notably, he sees little contagion and therefore by implication little reason why the ECB monetary policy should respond., “…unless the rest of periphery starts weakening? “He added that the recent sell-off has not had any significant impact on other members, playing down fears that Italy’s troubles could spread to others, like Portugal, Spain or Greece.”

    • The game today is watching for any resistance to the US rate move and how it plays out with the data on Friday still the key turning point for the weekly picture. Expect that at 3.22% and 3.25% today. For the USD this matters as well and perhaps the tail can wag the dog. The EUR holding 1.1450 matters, same with GBP 1.29 and JPY 114.50.  If USD breaks out like 10Y rates pay attention. 

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