Fixed income market: the week ahead

Fixed income market: the week ahead

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  We believe it hasn't arrived the time to short bonds yet. This week's Jackson Hole symposium will be a virtual event. It confirms that policymakers still take the threat coming from the Delta variant's seriously, giving Powell little room to be hawkish. Yet, this week 2-, 5- and 7-year US Treasury auctions will be critical to gauge market expectations ahead of the meeting. Rates can fall further before seeing a sharp steepening of the yield curve in autumn. Ten-year yields have the potential to try support at 1% before rising above 1.70% before year-end. Long-term US Treasuries are going to underperform other maturities as interest rate hikes need to be pushed forward.


I’ll admit I have difficulties writing today’s “The Week Ahead”. Since I came back from the holidays, market signals are incredibly confusing. The new Delta variant, tapering talks, and inflation pressures are pulling rates in different directions. The market so far has decided to take a prudent approach and stick to safe havens as price pressures and growth seem to subside. Yet, the challenge for bond investors to put their money at work remains. With deeply negative real interest rates, it’s difficult to lock in positive returns; and taking risk often becomes the only option.

We can confidently say that while 2020 was a drop tower, 2021 feels like a roller coaster. Ten-year yields rose from 0.82% at the beginning of the year to 1.75% in March; then, they gradually dropped to 1.2%. The reflation trade was a clear driver of higher yields in the first part of the year. However, supply-chain bottlenecks slowed manufacturing growth, provoking a shock in consumer sentiment, which recently plummeted to a decade-low. Adding to fears, the new Delta variant caused new lockdowns worldwide, further hindering growth. All of a sudden, safe havens such as US Treasuries and Gold look attractive.

Yet, US Treasuries' recent rally cannot be explained just by a simplistic risk-off trade. Indeed, by spring, the market was incredibly short US Treasuries. The plunge in yields aggravated when traders wound down large short positions as rates broke critical technical levels.

As rates were falling, stocks thrived. However, will bond yields remain low for longer to support the massive house of cards that has formed in the equity market?

The short answer to that question is yes, in the short term. Yet, as we approach the fall, we will see significant changes in the bond market, which will inevitably cause a sharp steepening of the yield curve, exposing the market's vulnerabilities.

Currently, we can identify five main drivers to rates:

Supply-demand of US Treasuries

The Federal Reserve is looking to scale back its monetary stimulus. At the same time, the US Treasury is looking to reduce coupon issuances from November. That cannot be a coincidence. If demand drops together with supply, volatility in the bond market should be contained. There is a catch, though. The US Treasury is looking to make significant cuts on the front-end of the yield curve and increase the weighted average maturity above 70 months. That means that long-term rates will remain vulnerable, and there is the potential to sharp bear-steepening of the yield curve as tapering unfolds.

The pace of tapering

All Fed’s members agree that tapering must begin, but they don’t agree with is its start date. That’s why the probability for a tapering announcement during the Jackson Hole symposium is low. Powell would rather wait until the 22nd of September meeting, which means that the central bank will not reduce purchases before October. Yet, the big unknown is how aggressively the central bank is going to taper. An aggressive pace of tapering will be more crucial to the bond market than its start date. And low-interest rates and record volumes at the Fed's Reverse Repurchase facility enable the central bank to taper aggressively.

Economic growth

Economic growth in the third quarter was slower than expected due to the Delta variant. While rates reflect the market's fear that growth will continue to be slow even during the last quarter of the year, lower Q3 growth may lead to higher Q4 growth. It means that we could see a revival of the reflation trade in autumn. Whatever happens, it's undeniable that growth will continue to be incredibly high this year and the next. The Conference Board estimates that this year's GDP growth will reach 6.0% YoY and 4.0% in 2022. That's the highest we have seen in more than forty years! If that is not enough to talk about higher rates, then try me!

Inflation outlook and developments may push forward interest rate hikes

You may think that the worst has passed and that inflation peaked in June. Yet, it’s not clear when the Personal Consumption Expenditures will fall back below 2.5%. Tapering might contribute to cooling inflation off; however, there is no direct link between the two. Indeed, tapering decreases the stimulus that the economy is receiving, but the economy will continue to be stimulated until a complete wind-down of QE. Hiking rates is a much better tool to deter inflation. We believe that the market is too conservative in pricing only three rate hikes for the next three years. If inflation numbers stay high, the market will need to price more hikes, pushing higher nominal and real yields.

Market liquidity

The Reverse Repurchase facility can be a proxy of the amount of liquidity in the market. The RRP at the moment is over a trillion dollars. To put it simply: the market has enough cash for another nine months of quantitative easing once tapering ends. Only when we see volumes in the RRP falling will we know that pressure on yields will be lifted off.

We can conclude that the Jackson Hole might do little to lift rates. Indeed, the event will take place virtually, showing that policymakers are taking seriously the threat coming from the Delta variant, and it's no time to be hawkish. In addition, liquidity remains at record high levels in the market. Friday’s PCE deflator might be more critical for markets to adjust monetary policy expectations.

We can conclude that while rates long-term trend is to rise, there continue to be considerable compressing pressure in the near term. Therefore, it isn't time to short bonds yet.

Looking at 10-year US Treasury yields, they confirmed a double bottom pattern and remained above 1.22%, forming what looks like a "head and shoulder" formation. We might see yields dropping again to 1.12% to form the right shoulder to ultimately break below this level and find support at 1%. If that were the case, we might see the formation of a larger shoulder, which would imply 10-year yields should break above 1.70% by year-end.

Source: Saxo Group and Bloomberg.

After 30-year yields failed to break above their 50- and 200-day moving averages, we might see yields falling below 1.80% in the short term. However, their long term trend remains bullish, and we will probably see them rising well above 4% at the end of the fourth quarter.

Source: Saxo Group and Bloomberg.

Economic Calendar

Monday, the 23rd of August

  • France: Manufacturing, Composite and Services PMI
  • Germany: Manufacturing, Composite and Services PMI, Bupa Monthly Report
  • Eurozone: Manufacturing, Composite and Services PMI, Consumer Confidence
  • United Kingdom: Manufacturing, Composite and Services PMI
  • United States: Manufacturing, Composite and Services PMI, Existing Home Sales

Tuesday, the 24th of August

  • Japan: BoJ Core CPI
  • Germany: Gross Domestic Product, Import Price Index
  • United Kingdom: 5-year Treasury Gilt Auction
  • United States: New Home Sales, 2-year Note Auction

Wednesday, the 25th of August

  • New Zealand: Trade Balance, Export and Import
  • Spain: Producer Price Index
  • Germany: Business Expectations, Ifo Business Climate Index
  • United States: Core Durable Goods Orders, 5-year Note Auction

Thursday, the 26th of August

  • Australia: Private New Capital Expenditure
  • Germany: GfK German Consumer Climate
  • France: Business Survey, Industrial Investment
  • Italy: Industrial Sales, Italy to sell Bonds (TBC)
  • Eurozone: M3 Money Supply, Loans to Non-Financial Corporations
  • United States: PCE Prices (Q2), Gross Domestic Product Q2 revision, Real Consumer Spending, Kansas City Fed Composite and Manufacturing Index, 7-year Note Auction

Friday, the 27th of August

  • France: Consumer Confidence
  • Italy: Consumer and Business Confidence
  • United States: Core PCE Price Index (YoY, MoM), Personal Spending and Income, Real Personal Consumption, Retail Inventories, Michigan Consumer Sentiment, Michigan Current Conditions, Michigan Inflation Expectations, Dallas Fed PCE

Saturday, the 28th of August

  • Jackson Hole Symposium

Quarterly Outlook

01 /

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
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.