Lagarde’s Blog Post

On Monday May 23rd, Christine Lagarde the head of European central bank (ECB) gave guidance in a blog post regarding the interest rate future path in the coming months signaling that the dispute on the Euro currency interest rates has been won by the hawks to fight back unprecedent inflation. Unlike what was announced back in December 2021 that it is unlikely that the ECB will raise interest rates in 2022 however, May 22nd announcement of 25 basis point increase in July and September and the halt of bond buying was highly predicted as significant number of policy makers requested immediate change in monetary policy on March 2022 meeting where March and April CPI were 7.4% with the highest change in CPI YoY at 1.5.


On mid May 2022 Dutch central bank chief Klass Knot mentioned the possibility of a half point rate hike if required however as mentioned , Lagarde said that the policy normalization will be gradual on the other hand, with inflation running 4x the targeted 2%, raising the deposit rate by 50 basis points through September would still put the central bank behind peers like the Federal Reserve and the Bank of England, who’ve increased borrowing costs this year to absorb surging inflation and If inflation doesn’t wane to the 2% zone target then we would expect taking interest rates to the positive territory by Q4 2022 or early 2023.


                                                                                                                 Source: graph developed by the writer

                                                     Source:                                                                                         Source: graph developed by the writer


The inflationary sentiment and consumer confidence which is currently at its lowest has been priced by fixed income markets. Referring to German sovereign bonds, the 10 years bond yield spiked in January 2022 from -0.0.815% to 0.032%. Yields for the 5 and 2 years bonds spiked in February and March from -0.303% to 0.079% for the 5 years bond and from -0.0813% to 0.066% for the 2 years bond. During the period between November 2021 and February  2022 the Euro was at a trading range between $1.11 and $1.15, the trading range’s support level was broken downward late February 2022  for a down trend to resume coinciding with the Federal reserve 25 basis rate hike, higher inflation at 5.8% and a lower consumer confidence at 11. 7.



Until mid May 2022 the Euro lost almost 7% of its value within two months against the USD  at which both were almost at parity ( EURUSD=1.035 at mid May 2022), and while no action has been taken by the ECB since Q4 2021, Lagarde’s announcement about an intentional change in the monetary policy gave some air to the depreciating Euro as it regained 3% in two weeks from mid May 2022 till to-date, trading at $1.075 at the time this report is developed. The EU’s GDP growth rate has been in constant growth for the last three quarters Q2 2021 at 4.2% , Q4 2021 at 4.8% and Q1 2022 at  5.2 , in parallel the unemployment rate has been below 7 since January 2022 with the latest April record of 6.2% however with the latest inflation report in May 2022 at 8.1% of which the energy prices are the main contributor for the inflation spike since energy prices has increased by 39% from 37% in April 2022 and the consumer confidence reaching its lowest is pushing the ECB to apply aggressive tightening to slow down inflation progression, maintain the unemployment down trending curve and retrieving a positive consumer confidence, on the other side, GDP growth rate would slow down in an unreferred momentum specially if energy prices would retrace in the near future.


Given that the markets have already priced Lagarde’s blog, sovereign bonds would maintain the same levels for the coming period, reaching a positive territory would push the 10 year bond yield to 2.3% , the 5 bond yield to 1.3% and the 2 years yield to 0.9%.  On the weekly chart The Euro is targeting to test monthly resistance at $1.08 followed by $1.09 and $1.11-1.12. Current support levels are $1.065,  $1.055 and $1.047.



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