Fixed Fixed Fixed

Fixed income market: the week ahead

Bonds
Althea Spinozzi

Senior Fixed Income Strategist

Summary:  This week it's all about the nonfarm payrolls and whether the Federal Reserve will taper purchases under its QE program in November or not. A strong jobs report will hint at a November tapering and more aggressive monetary policies ahead, contributing to a bear flattening of the yield curve. However, a weak nonfarm payrolls report might not necessarily revive the attractiveness of US Treasuries. Indeed, it's becoming apparent that inflation will be a more significant driver than jobs and growth in the future, leading to more aggressive monetary policies anyway. To weigh on long term yields might be the debt ceiling dilemma. Short term T-Bills are offering now a yield more than double than the one of the RRP facility rate. If a resolution is not found, we expect yields to continue to rise in money markets while dropping in longer-term maturities as investors fly to safety. In Europe, ECB speakers and the Minutes for the September ECB policy meeting will be in the spotlight as investors try to come to terms with high inflation.


Will US Treasury yields continue to rise?

That’s the question on everybody’s mind as we are approaching a critical nonfarm payroll on Friday. Last month's jobs miss lead doves to believe that the Fed would postpone tapering further down the line, as their maximum employment target has not been met yet. However, we believe that is just wishful thinking. Indeed, jobs continue to recover while there is no sign yet that inflation is as transitory as the Fed wants us to believe. That makes inflation the primary driver of monetary policies since sustained price pressures will need to be met with unexpected aggressive monetary policies.

There is more potential for jobs to surprise on the upside than to the downside in September, pushing the market to consider an aggressive rate hike path. On one side, jobs openings are at record-high levels. On the other, unemployment benefits expired at the beginning of September, forcing lower-paid labour to return to work. However, to put a strain on the jobs recovery might be the debt ceiling dilemma as budget uncertainties and a potential upcoming government shutdown led to a slower recovery of jobs in the public sector compared to the private sector.

A strong jobs report will definitively weigh on the bond market leading to higher yields in the belly of the curve, but a weak jobs report might not equally lead to lower yields as it’s becoming clear that more aggressive monetary policies will be unavoidable going forward. Doves often point to a slowdown in growth as one of the reasons for the FED to keep dovish. Yet, growth is not contracting: it’s decelerating from extremely high levels brought by the reopening of the economy and base effects. Therefore, it's unlikely that the Fed's tapering agenda will halt in light of slower but sustained growth.

Another question that investors will ask themselves is whether we will see a steepening or a flattening of the yield curve.

Indeed, in the past few days, we have seen the yield curve steepening substantially, with the 2s10s spread widening to 120bps and the 5s30s spread widening to 111bps after plunging below 100bps in the wake of the latest Fed decision. However, the yield curve remains flat compared to the beginning of the year. That is a problem for the Federal Reserve because in case it needs to hike interest rates earlier, it would require the yield curve to be steeper to rule out the risk of curve inversion.

During the last FOMC meeting, the message surrounding rate hikes was bleak. The Eurodollar strip began to price more aggressive monetary policies already starting by this year, considering a 15bps rate hike by December. The potential for early interest rates hikes remain elevated and adds to the risk of a bear flattening with the belly of the curve rising fast and long term yields dropping signaling a Fed’s policy mistake ahead, especially if the market remains preoccupied about slower growth. If the market accepts that slower but sustained growth is no risk, we should see the yield curve steepening instead of bear flattening.

Lastly, debt ceiling talks are becoming more and more important for money markets. On Friday, the yields on T-Bills with maturity at the end of October and the beginning of November doubled in yield. This morning T-Bills with maturity November the 2nd offer 11bps, more than double of the RRP facility. As debt ceiling talks continue without finding a resolution, we can expect more volatility in money markets leading to a bead flattening of the yield curve, which would drag long term maturity lower as they will be seen as a safe haven.

Regarding the supply of US Treasuries, there are no significant auctions this week. Still, next week the Treasury will sell long maturity, which might contribute to bearish sentiment to the longer part of the yield curve.

Source: Bloomberg and Saco Group.

European government bonds begin to take into account hawkish sentiment among ECB members.

Inflation might soon become a problem for the European Central Bank as well, as it rose to 3.4% YoY in September, with core inflation hitting 1.9%, well above ECB’s expectations. Yet, yields remain stable and continue to be correlated to the US Treasuries, signaling that the market trusts the central bank to stick to its recently communicated symmetric inflation targeting.

However, it may be just the quiet before the storm because soon European sovereign yields will be pushed higher by several fronts:

  1. Higher yields in the United States;
  2. The formation of a German governing coalition which includes the Greens and the SPD, hinting at more Bund issuance;
  3. Sustained inflation and high energy prices lead to more hawkishness within the ECB.

However, the above elements will be in play until the end of the year and potentially until the beginning of 2022.

In the meantime, we could see European yields trading sideways amid a heavy economic calendar. The German economy will be in the spotlight with the release of PMI figures, factory orders, industrial production and trade data. Retail sales figures in the Eurozone will also be out on Wednesday.

To weigh on European sovereign bonds this week are the long list of ECB members speaking and the release of the September ECB Minutes on Thursday, which could give an insight into the central banks' conservative inflation forecasts.

Economic Calendar

Monday, October the 4th

  • Spain: Unemployment Change
  • Canada: Building Permits
  • United States: Factory Orders (Aug), NY Fed Treasury Purchases 22.5 to 30 years

Tuesday, October the 5th

  • Australia: Markit Services PMI Final (Sept), Balance of Trade (Aug), NAB Business confidence, Retail Sales MOM Final, RBA Interest Rate decision
  • Japan: Tokyo CPI YoY, 10-year JGB Auction
  • United States: Total Vehicle Sales, Balance of Trade, Markit Composite and Services PMI (Sept), ISM Non-Manufacturing PMI, NY Fed Treasury Purchases 7 to 10 years
  • France: Industrial Production (Aug), Markit Composite and Services PMI (Sept)
  • Spain: Markit Composite and Services PMI (Sept), Consumer Confidence
  • Italy: IHS Markit Composite and Services PMI (Sept)
  • Germany: Markit Composite and Services PMI (Sept)
  • Eurozone: Markit Composite and Services PMI (Sept), Producer Price Index (Aug)
  • United Kingdom: Markit/CIPS UK Composite and Services PMI (Sept), New Car Sales
  • Canada: Balance of Trade

Wednesday, October the 6th

  • New Zealand: Interest Rate Decision
  • Germany: Factory orders (Aug), Construction PMI, 5-year Bobl Auction
  • Spain: Industrial Production (Aug)
  • Eurozone: Construction PMI (Sept), ECB Non-Monetary Policy Meeting, Retail Sales (Aug)
  • France: Construction PMI (Sept)
  • Italy: Construction PMI (Sept)
  • United Kingdom: Construction PMI (Sept)
  • United States: ADP Employment Change (Sept)

Thursday, October the 7th

  • Japan: Foreign Bond Investment, Coincident Index Preliminary, Leading Economic Index Preliminary
  • Netherland: Inflation Rate
  • Germany: Industrial Production
  • France: Balance of Trade, 10-year Bond Auction, 30-year Bond Auction, 45-year Bond Auction
  • Italy: Retail Sales (Aug)
  • Spain: To sell bonds (maturities to be confirmed)
  • United States: Continuing and Initial Jobless Claims, Consumer Credit Change (Aug), 4-week and 8-week T-Bill Auctions
  • Canada: Ivey PMI (Sept)

Friday, October the 8th

  • Japan: Household spending (Aug)
  • Australia: Building Permits Final (Aug)
  • China: Caixin Composite and Services PMI
  • Germany: Balance of Trade
  • Ireland: Inflation Rate
  • Canada: Employment Change (Sept), Unemployment Rate (Sept), Average Hourly Wages (Sept)
  • United States: Nonfarm payrolls (Sept), Unemployment Rate (Sept), Average Hourly Earnings (Sept), Participation rate, Wholesales Investors (Aug)
Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.