Head of Fixed Income Strategy
Summary: This week, US Treasuries might reverse their recent gains and yields to resume their rise to 2%. The Federal Reserve will likely maintain its accommodative stance, but it may need to improve its economic forecasts. On Friday, the Personal Consumption Expenditures (PCE) Index is expected to rise to 1.8%, close to the Fed's target rate. Any inflationary surprise might revive the reflation trade. In Europe, government bonds will be sensitives to changes in sentiment in US Treasuries. After last week's ECB meeting, it's clear that the central bank will not make any changes to current monetary policies until the German elections. In Japan, the BOJ's economic outlook tomorrow will be in focus as a surge in Covid-19 cases might hinder economic activity during the Golden Week's holiday starting this week.
Some Like it Hot
No, it’s not the replay of Marylin Monroe’s movie. It will be the stance of the Federal Reserve over inflation at Wednesday’s FOMC meeting.
We don’t expect any policy move, yet the Fed needs to acknowledge that the economy is improving and revise its economic outlook. It means that there the risk that inflation overshoots the Fed's target rate is increasing. Still, the central bank will stubbornly continue with its ultra-accommodative monetary policies until its goals of “full employment” is fulfilled. We believe the FOMC meeting is shaping to be a non-event because the bond market has already priced the inaction of the Federal Reserve. Thursday and Friday's gross domestic product and personal consumption expenditure (PCE) data will be a more significant test for US Treasuries. PCE numbers are expected to show a 1.8% rise in inflation; if they surprise on the upside, they would be extremely close to the Fed's target rate of 2%. It could be enough to wake up the bond vigilantes, forcing the market back into the reflation trade.
The recent rally in Treasuries has been supported by renewed Japanese bond-buying, additional liquidity from the Treasuries General Account, and stabilizing Breakeven rates. However, the uptrend in yields remains intact. Thus, any surprise coming from economic data, Fed monetary policies or weak demand at today and tomorrow’s 5- and 7-years notes auctions could trigger a selloff that will force 10-year Treasury yields to trade above 1.6%.
As inflationary pressure continues to strengthen, we believe that the only level worthwhile monitoring and where we will see ample support is 2%.
European sovereigns remain at the mercy of US Treasuries until fall
The message of last week’s European Central Bank meeting was clear: status quo until the German elections. It means that European government bonds will remain vulnerable to changes in US Treasury yields from now until fall. It is something that the ECB shouldn't be pleased with since US yields will most likely resume their rise, pushing the cost of funding higher in Europe too.
We believe that increased purchases under the PEPP framework have proved useless. Indeed, the correlation between EU sovereigns and the US safe-havens remains intact. The ECB needs to substantially increase purchases under this program if it wants to keep yields stable in the euro area. In our opinion, the reluctance of the ECB to increase firepower under this program shows a vital concern regarding uncertainties surrounding the German election. Additionally, collateral scarcity remains an issue for the ECB has been buying more bunds than issued starting from the Covid-19 Pandemic.
Bond investors should prepare for higher yields in Europe. A correction will be most felt in those countries where bond yields continue to be close to zero or negative, such as Germany and France. Ten-year Bund yields remain capped by their resistance at -0.2%. However, if this is broken, they might rise fast to try residence at -0.15%, leading them to a fast track to 0%.
This week Italy is issuing 10-year BTPs; we do not expect volatility surrounding this auction. Yet, it will be essential to see if any weakness in bidding metrics is observed.
BOJ interest rate decision
We expect the BOJ to keep monetary policies unchanged a month after the central bank reiterated its commitment to continue monetary easing via YCC for a long time. Yet, there are concerns regarding the recent surge in coronavirus, which may further weaken the service sector during this week's Gold Week holiday. Hence, the updated economic outlook will be crucial to understand whether financial estimates are still valid at the beginning of the year.
JGBs, together with Chinese government bonds, have helped bond investors to preserve value since the beginning of the year. Indeed, while US Treasuries fell 3.3% and European sovereigns plunged 2.8% year to date, Chinese government bonds rose by 1.5%. At the same time, JGB were able to provide a return slightly above zero. Suppose the macroeconomic condition deteriorates, and the BOJ is forced to continue to be aggressive. In that case, JGBs may continue to provide a much-needed shelter as bonds fall worldwide.
Economic Calendar:
Monday, April the 26th
Tuesday, April the 27th
Wednesday, April the 28th
Thursday, April the 29th
Friday, April the 30th
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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.
