07:53 AM EDT, 05/08/2024 (MT Newswires) -- Bond yields stayed lower overnight after the impressive price rally on Tuesday led by the long end deflated the 10-year German Bund to 2.42% and the 10-year United States Treasury (UST) to 4.43%, some 30bps below the April high, said Societe Generale.

The resulting bull flattening in spreads is at odds with the bull steepening in the wake of disappointing US data and Federal Reserve Chair Jerome Powell's dovish iterations a week ago on the outlook for interest rates. The bank wrote in a note to clients that it understands from sources on the trading side that the drop in yields from the seven-year bucket out is likely driven by the rebalancing of positions relative to fixed income benchmarks.

This month sees a reported 80 billion euros of bonds with a one-year minimum maturity falling out of indices, the third-largest such month this year after March and October. The reinvestment of cash proceeds explains the counter-intuitive flattening. This reinvestment must pass before markets can revert to bull steepening associated with the rolling over of the US Citi macro surprise index to -7.5, the lowest level since February 2023, stated SocGen.

Two inside days on the trot since last Friday for EUR/USD right below the 200dma (1.0793) speak volumes about conviction. With no major data in the US or the eurozone, Federal Reserve speak will dominate alongside the stats of the 10-year refunding auction. The three-year sale on Tuesday was well received with stop through 0.3bp, non-dealer bidding of 85.1%, b/c 2.63 times and indirect bid of 65.5%. FOMC non-voter Neel Kashkari made the interesting point on Tuersday that the June dot plot would contain just two rate cuts this year instead of three, in line with market pricing. Speaking at the Milken conference, Kashkari mentioned that persistent housing inflation is a potential indicator that the neutral interest rate may be higher in the short term. He raised his longer-run neutral rate forecast to 2.5% from 2%.

Early Wednesday Sweden's Riksbank lowered the repo rate by 25bps to 3.75%, the first cut since 2016. The central bank had previously lowered the rate path substantially, hinting that first easing could come in H1. Friendly inflation data and the surprise contraction in Q1 gross domestic product (GDP) made Wednesday's decision a formality, pointed out the bank.

The statement was dovish and signaled two more cuts in H2 so a target of 3.25% by the end of the year. This is in line with SocGen's forecast for the Euroepan CEntral Bank (ECB) but the sensitivity of the krona (SEK) to UST and Bund yields is the differentiating factor for EUR/SEK and USD/SEK. For NOK/SEK, the greater reluctance of Norway's Norges Bank to lower rates translates into a potential upside for NOK/SEK with the January high of 1.0066 an obvious short-term objective.

For USD/SEK, the danger now is another "hot" US consumer price index (CPI) print next week, added SocGen. This would cement the case for no (fewer) Fed cuts, and the potential for widening in the US/Swedish spread from the current 175bps to 225bps by year-end based on the bank's house view of the US status quo. Topside is situated at 11.0495. A break would bring 11.20/27 into play. The Riksbank will publish updated growth and inflation forecasts at the next meeting on June 27.

SocGen penciled in a 25bps rate cut at Brazil's central bank (BCB) on Wednesday to 10.50%, deviating from the 50bps that had become the modus operandi since September. The BCB dropped the plural from its forward guidance at the March meeting, calling for another 50bps in the next "meeting" rather than "meetings." Officials have sounded more circumspect about inflation in recent weeks, adjusting to the global inflation narrative and revised fiscal ambitions of the government.

This puts a smaller 25bps reduction on the table after six consecutive half-point moves. SocGen raised its 2024 and 2025 Selic rate forecasts from 8.75% and 8.25% to 9.75% and 8.75% respectively. A hawkish statement could be a fillip for the real(BRL) and pave the way for a retest of 5.00 if 5.05 (50dma) can be overcome.

Inflation data from Chile put the spotlight on local data for the peso (CLP) after the "whopping2 5.2% rally in 2Q (spot versus the US dollar, or USD) catapulted the peso to the top of the emerging market (EM) rankings, noted the bank. Chained CPI likely edged up a tick to 3.8% in April from 3.7% in March. USD/CLP returned below 930 for the first time in three months, powered by the over 15% rally in copper in Q2 to above $10,000/MT (LME) for the first time in two years on tighter supply and optimism around China demand.

Elsewhere, USD/ZAR is trading just below 18.50 for only the second time in four months, posing the question of whether the rand's (ZAR) resilience can last as South Africa prepares for a presidential election in three weeks, according to SocGen. The ZAR is the second-best performing currency so far in Q2 (+2.1% versus USD) after the CLP, but the latest leg of the rally in the first week of May is on account of the 20bps decline in the two-year UST yield.

According to the latest IPSOS poll (March 9 and April 15), ANC support is little changed at 40.2% versus 40.5% in February. The ideal scenario for the rand would be a majority consisting of the ANC and smaller parties including the Inkatha Freedom Party (IFP), Patriotic Alliance (PA) and African Independent Congress (AIC). The resilience in spot belies the rise in implied one-month volatility to above 15. The worst-case outcome for the currency is an alliance comprising the ANC and the leftist EFF party or former President Jacob Zuma's MKK party.