Head of Fixed Income Strategy
Summary: The latest data on core and headline PCE in the US met expectations, but the six-month annualized data increased to 2.5% and 3.1%, respectively, up from 1.9% and 2.5% in the previous month. In Europe, core and headline CPI dropped at a slower pace than what economists had predicted. These movements are likely to set a floor for bond yields as central banks will become more cautious in reducing interest rates in the near future. As a result, government bond yields on both sides of the Atlantic are expected to remain rangebound until the macroeconomic outlook becomes more evident.
The highlight of the week has been inflation, with the PCE deflator meeting expectations, rising +0.3% monthly and 2.4% YoY, the lowest since February 2021. However, the core PCE remains sticky, running at 0.42% MoM. The problem with this report is that while core PCE was running at 1.9% on a six-month annual basis the month before, after this week's report, it rose to 2.5%. Also, headline PCE rose from 3.1% to 2.5% on a six-month annualized basis, showing that the disinflation story might be losing steam.
In the meantime, inflation expectations are rising. The 2-year US breakeven rate rose near 2.5%, the highest since March 2023, while the 5-year US breakeven rate rose to 2.78%, the highest since March 2023. Breakeven rates are calculated as the spread between nominal bond yields and inflation-linked bond yields and represent market expectations on inflation in a few years. Inflation expectations are important because they influence decisions about consumption and investment. For example, if corporations expect inflation to be higher in two years, they would spend today, fueling inflation further. Rising breakeven rates are bearish for bonds and create a floor for US Treasury yields.
In Europe, headline and core inflation continue to fall, but slower than economists expected. There are signs that the 3-month and 6-month annualized headline and core inflation have bottomed, building the case for less aggressive rate cuts by the ECB. However, the recent drop in CPI will enable the ECB to revise the staff inflation projections for this year downward at next week's ECB monetary policy meeting, giving a modest boost to European sovereign bonds, as illustrated in our ECB preview.
However, interest rates will likely trade rangebound until the macroeconomic picture and disinflationary trends become clearer.
14 Feb Higher CPI shows that rates volatility will remain elevated.
12 Feb Ultra-long sovereign issuance draws buy-the-dip demand but stakes are high.
06 Feb Technical Update - US 10-year Treasury yields resuming uptrend? US Treasury and Euro Bund futures testing key supports
05 Feb The upcoming 30-year US Treasury auction might rattle markets
30 Jan BOE preview: BoE hold unlikely to last as inflation plummets
29 Jan FOMC preview: the Fed might be on hold, but easing is inevitable.
26 Jan The ECB holds rates: is the bond rally sustainable?
18 Jan The most infamous bond trade: the Austria century bond.
16 Jan European sovereigns: inflation, stagnation and the bumpy road to rate cuts in 2024.
10 Jan US Treasuries: where do we go from here?
09 Jan Quarterly Outlook: bonds on everybody’s lips.
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
