Market momentum is building behind the global growth slowdown narrative, with last week’s downbeat European Commission forecast report triggering a safe-haven bid. The eurozone, in particular, is caught in the crosshairs with the German and Italian economies buckling under the weight of an industrial slowdown. The market is becoming more convinced that a deflation shock is coming with the EUR 5y5y forward inflation swap falling back to 2016 levels, at which point the eurozone was struggling to escape its last deflation shock.

The rates markets have adopted a similarly bearish position with the implied probability of an inconsequential 10bps deposit rate hike by the December 2018 ECB meeting falling to 38% from 90% at the beginning of the year. EURUSD may see some downside, but nonetheless should remain more resilient than otherwise would be expected. The eurozone still runs a large current account surplus which is a natural powerful support for the currency (bottom-left chart). Furthermore, demand from Japanese buyers of European debt is falling as the hedged yield pick-up compared to JGBs continues to fall (last chart).

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Source: Bloomberg, Macrobond and Variant Perception