Head of Fixed Income Strategy
Summary: We exclude that the recent inversion of the yield curve between 5 and 30 years signals a recession as real yields remain in deeply negative territory. We believe that there is room for 2-year US Treasury yields to continue to rise to 2.85% in the mid-term. However, today's 2-year and 5-year note auctions might briefly pause the bond selloff, as both tenors offer the highest yield in three years. We anticipate the yield curve to continue to bear-flatten with this week’s PCE Index and nonfarm payroll data in focus. In Europe, we expect yields to continue to soar and more parts of the German yield curve to turn positive as the market expects an aggressive ECB to hike rates by 50bps this year. This Friday’s eurozone CPI figures will be in focus.
Dear readers, this will be the last “Fixed income market: the week ahead” before entering maternity leave. Unfortunately, I have to step back during an exciting time for markets. Still, I assure you I will be back full of energy!
US Treasuries’ move has been considerable last week and today. The US yield curve has accelerated its flattening with the 5s30s spread inverting this morning for the first time since 2006. The whole yield curve is shifting higher. However, short-term yields are rising faster than long-term yields. Significant has been the 2-year US Treasury yields move, which broke above their falling decennial trendline. If they continue to soar, they will not find resistance until 2.85%, which coincidentally matches the Fed fund rate forecasted by the dot plot in 2023 and 2024.
To lead the fast rise in US Treasury yields is the swap market, which now is pricing 200bps additional hikes this year. Moreover, several investment banks adjusted their Fed’s hiking forecasts to reflect the expectations of a more aggressive Fed, which might need to hike rates by 50bps several times this year.
Although investors might quickly pin the flattening and inversion of the yield curve on an upcoming recession, it's essential to put things into context.
First, the long part of the yield curve is not falling but steadily rising, indicating taht the bond market is not concerned about an imminent recession. Ten-year yields are, like two-year yields, on the way to testing their descending decennial trendline and their 200 monthly simple moving average at 2.66%. If they break above this level, they will not find resistance until 3.15%.
Negative real yields are another factor that helps to exclude the possibility of an imminent recession. Indeed, while nominal yields have risen drastically, real yields remain in deeply negative territory, keeping financing conditions extremely easy. However, the more aggressive the Federal Reserve becomes, the faster the rise in real yields, which could cause a sudden tightening of financial conditions affecting weaker corporates.
Yet, we believe that the US economy remains strong at the moment, enabling the central banks to implement tighter monetary policies. In the second half of the year, we might better know whether the economy is facing the risk of a recession.
Today’s 2-year and 5-year US Treasury auctions will be in focus, as ugly-tailing auctions would suggest that the market expects the Federal Reserve to grow even more aggressive. However, the recent bond selloff will allow investors to buy into the highest yields in three years. Therefore, high participation at today's Treasury auctions is more probable, even if we believe there is room for two-year yields to continue to rise.
This week's Federal Reserve speakers, Thursday's February figures on personal income and spending, and Friday's nonfarm payrolls might exacerbate or slow down the rise in yields. If economic data show that inflation continues to rise while the unemployment rate falls, it could build the case for more aggressive monetary policies.
European sovereign yields
European investors will look out for Friday’s eurozone CPI release, which is expected to hit 6.7% in March following a 5.8% reading in February. In the meantime, investors understand that the ECB will unlikely remain accommodative to avoid the same fate of the BOJ. Indeed, by accentuating monetary policies' divergence with the Federal Reserve, the Japanese Yen plunges, welcoming even more inflation.
So far, the market is pricing 50bps ECB rate hikes by the end of the year. Consequently, European sovereign yields continue to rise, with 2-year German yields at -0.14%, rising to 0%, which they didn’t break since 2014.
Economic calendar
Monday, March the 28th
Tuesday, March the 29th
Wednesday, March the 30th
Thursday, March the 31st
Friday, April the 1st
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