Fixed income market: the week ahead Fixed income market: the week ahead Fixed income market: the week ahead

Fixed income market: the week ahead

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  This week's focus will be on the FOMC minutes. The report could show growing divergence concerning the transitory nature of inflation among members, pushing forwards tapering expectations. The summer lull will keep US Treasury yields rangebound. However, August will be pivotal as there are increasing doubts regarding an extension of the debt ceiling's suspension, and the Treasury is preparing for a drawdown of the Treasury General Account (TGA). Elements are indicating that either the Federal Reserve needs to accept negative T-Bill yields or taper aggressively. We believe the second to be the most probable outcome. Thus, mid-term, we expect the US yield curve to continue to bear-flatten as the Fed engages more aggressively in tapering talk. Yet, yields will shift higher as inflationary pressures begin to look less transitory in autumn. In Europe, the focus is on the ECB's special strategy meeting, which could extend its accommodative monetary policies.


Dear reader, this will be the last Fixed income the week ahead before the summer break. I will finally go to Italy after more than a year of Danish confinement to get plenty of pasta, pizza and sun. The week ahead will resume on the second half of August. However, I will be returning at the end of the month for our regular monthly Fixed Income Update webinar. You can sign up by clicking on it here.

While many of us are heading towards a well-deserved vacation, the market is yet to pack its bags. Friday’s strong nonfarm payrolls failed to revive the reflation trade as the report gave contradictory messages. Jobs grew together with the unemployment rate. Wages increased the most since the Global Financial Crisis of 2008/09, but working hours fell. It’s clear that although the job market is recovering, we are still far away from the Fed’s full unemployment target. Hence, the market expects the central bank to continue to remain accommodative.

Yet,  we believe that investors are misreading the central bank message. While the full employment vision has dominated monetary policies since the Covid-19 pandemic, the last FOMC meeting sent contradictory messages. The Federal Reserve hiked interest rates in two key money market facilities and opened up to tapering despite jobs numbers missed expectations for two months in a row. We believe it is clear that the central bank is shifting its focus from jobs to inflation pressures.

Therefore, this week's minutes will be critical as they may give an idea of whether FOMC members are starting to be less confident about inflation's transitory nature and when the Fed could begin tapering its asset purchases. Regardless, US Treasury yields will most likely continue to trade rangebound until the Federal Reserve begins to engage more actively with tapering talks.

Excess liquidity, the resumption of a debt ceiling limit, and the Treasury General Account drawdown will continue to squash US Treasury yields. We may be facing T-Bills paydowns (when the government issues less debt than what is maturing), which, combined with a reduction of the TGA, translates into lower yields in the front part of the yield curve. Because T-Bills are already close to 0%, the Federal Reserve will soon need to decide whether to accept negative yields in the front part of the yield curve or to taper more aggressively than the market anticipates.

Concerns regarding a spike in volatility are rapidly growing. Money market guru Zoltan Pozsar begins to be troubled about the growing size of the Fed’s Reverse Repurchasing Facility (RRP). According to him, the sudden surge of RRP usage following the 5bps hike from the Federal Reserve implies that a large part of cash is rotating from bills to the RRP facility. However, T-Bills demand is crucial for future issuances. Zoltan says that the RRP is becoming an "active tool that sucks the deposits away that banks decided to retain”.

How does all the above come to play for bond investors? Everything is pointing to a negative T-Bills rate in the short term and a bear flattening of the US yield curve in the mid-term. It doesn't mean that long term yields will continue to fall. They might fall and break below 1.40% in the short-term, finding support next at 1.20%. Yet, as inflationary pressures become less transitory, we might see the yield curve shifting higher while bear-flattening.

Source: Bloomberg and Saxo Group.

The ECB special strategy meeting might pave the way to more accommodative monetary policies

As I am wrapping up for summer, the European Central Bank has decided to hold a special meeting in Frankfurt to finalize its strategy review, which began before the Covid pandemic. A broad range of topics will be discussed during this meeting, ranging from inflation, employment, climate change, and fiscal policy. The focus will be whether the ECB is leaning towards looser monetary policies as broad consensus show that the current inflation target of “below, but close to, 2%” should be replaced.

During the June 28-20 gathering, reports were saying that it was a general consensus that the ECB should tolerate inflation exceeding the current target. Thus, it opens up the possibility that the central bank might adopt a framework similar to the Fed's Average Inflation Targeting (AIT), which will enable looser monetary policies amid a temporary rise of inflation. Yet, Chief Economist Philip Lane said that he’s not willing to mimic the Fed. Therefore, the ECB might opt to change its inflation target to 2% as most developed central banks.

The discussion could shape ideas on exiting the PEPP program, which is set to be terminated in March 2022. Austria's Holzmann and German Weidmann last week were vocal about the guaranteed termination of the PEPP program next year. Bundesbank’s Weidmann even mentioned that the central banks should consider taper ahead of March to avoid any market shock.

Regardless of the above, we expect European sovereigns to continue to trade rangebound until the German election unless yields resume their rise in the United States. Indeed, it will be unlikely that the ECB will change its stance before the German election. However, things can quickly change in the fall as a new German government should bring about higher bond yields amid higher fiscal spending plans and better European integration. Higher yields imply tighter financing conditions. Therefore if the ECB moves too early, there is the risk that the conditions would tighten even faster.

Economic Calendar:

Monday, July the 5th

  • Australia: Building Permits, Retail Sales
  • China: Caixin Services PMI
  • France: Industrial Output, Markit Services PMI, Markit PMI Composite
  • Spain: Markit Services PMI
  • Italy: Markit Services PMI
  • Germany: Markit Services PMI, Markit PMI Composite
  • Eurozone: Markit Services PMI, Markit PMI Composite, Sentix Investor Confidence
  • United Kingdom: Markit Services PMI

Tuesday, July the 6th

  • Japan: Overall Household Spending
  • Australia: RBA Interest rate Decision and Statement, RBA’s Governor Lowe speech
  • Germany: Factory Orders, ZEW Survey- Current Situation and Economic Sentiment
  • Eurozone: ZEW Survey – Economic Sentiment, Retail Sales, Economic Commission releases Economic Growth Forecast
  • United Kingdom: 10-year Bond Auction
  • United States: Markit Services PMI, Markit PMI Composite, ISM Services New Orders Index, ISM Services PMI, ISM Services Employment Index, ISM Services Prices Paid

Wednesday, July the 7th

  • Japan: Leading Economic Index
  • Germany: Industrial Production, 5-year Bond sale
  • France: Trade Balance
  • Italy: Retail Sales
  • Canada: Ivey Purchasing Managers Index
  • United States: FOMC Minutes, Fed Monetary Policy Report

Thursday, July the 8th

  • Australia: RBA’s Governor Lowe speech
  • Switzerland: Unemployment Rate
  • Germany: Trade Balance
  • Eurozone: ECB Special Strategy Meeting
  • United States: Initial Jobless Claims

Friday, July the 9th

  • China: Consumer Price Index
  • United Kingdom: Manufacturing Production, Industrial Production, Gross Domestic Product, NIESR GDP Estimate
  • Italy: Industrial Output
  • Canada: Unemployment Rate, Net Change in Employment, Participation Rate, Average Hourly Wages
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.