Head of Fixed Income Strategy
Summary: Despite the recent bond rally, we find that the uptrend in yields is still intact. Inflation and interest rate expectations are driving pricing in the bond market, causing a bear flattening of the yield curve in the US. In Europe, sovereigns carrying a high beta remain vulnerable to the hawkish stance of central banks. In the UK, rate hike expectations are far more aggressive than in the US, hinting at a possible rally in Gilts if the BOE remains dovish during December's monetary policy meeting. The inevitable truth is that yields will be soaring worldwide, posing a threat to risky assets.
Ten-year yields are fluctuating between 1.40% and 1.70%, within their decennial downtrend.
As interest rate expectations continue to accelerate, the belly of the yield curve will be most vulnerable. Five year yields are in a uptrend. If yields break above 1.25% they can rise quickly to 1.40%.
While yields trend higher across the whole yield curve, thirty year yields lack of direction. They find strong support at 1.80%. Stable long-term rates are a sign that the market is expecting the economy to deteriorate.
The long part of the yield curve has flattened by 30bps since October falling form 100bps to 70bps. The 20s30s part of the yield curve is already inverted. If the Federal Reserve needs to hike interest rates earlier than expected, a flat yield curve might be a problem. Amid interest rate hikes, the front part of the yield curve rises faster than the long part. If the yield curve is too flat to start with, an inversion is possible posing a threat to the economy.
Interest rate hikes expectations are becoming more aggressive.
After being rejected just at the USD130 level a couple of times the 10 Year US T-Note experienced a massive sell off yesterday taking it back below USD131. During the rebound last week RSI failed to break above 60 which indicates we could see a re-test of the strong support around 130. If that scenario unfolds the US 10 year yield will rise above 1.75%. (Courtesy of Kim Cramer).
The US 30 year Ultra T-Bond has been trading in a rising channel for the past 4 weeks. The sell off yesterday on back of the CPI numbers has not changed that. The Ultra T-Bond future seems to have some support around the 55 Simple Moving Average at around USD195. A close below could initiate further sell-off and a potential reversal of the trend. However, the RSI being above 60 threshold supports the short term uptrend. (Courtesy of Kim Cramer).
Long-term US Treasuries have gained the most in the past six months. TLT:xnas rose 8.34%. IEF:xnas, which includes US Treasuries with 7 to 10 year maturities, rose 0.62%. The belly of the yield curve, IEI:xnas, plunged 1.25%. The front part of the yield curve up to 3 years, SHY:xnas, fell -0.59%.
German 10-year Bund yields have dropped sharply since the ECB dovish meeting of the end of October. However they bounced back after testing their 100 days moving average, Their uptrend is intact, and we expect Bund yields to resume their rise toward 0% as inflationary pressures strengthen.
The rebound in EuroBunds seems to be running out of steam back after being pushed down below the 55 Simple Moving Average which is falling. If the leading Interest rate Future in EU trades below EUR169.92 and the RSI breaks below the rising trend line, it could fuel further sell-off taking it down to re-test strong support area at around EUR168. For further upside a close above EUR171.44 is needed. (Courtesy of Kim Cramer).
Gilt yields have dropped sharply following the unexpected decision of the BOE to keep the base rate unchanged. The market had to scale back quickly on aggressive rate hikes expectations. Following yesterday’s strong CPI report in the US, Gilt yields bounced back. However, there is room for Gilts to rally before resuming their drop. Indeed, the market is still pricing four interest rate hikes in for 2022, far more than in the US. We could see yields testing again 0.82% before rising again towards 1.20%.
The market is pricing four interest rate hikes in the UK for September 2022 versus only one and half in the US. If the BOE remains dovish in the meeting of December, we could see the market scaling back hikes expectations provoking another rally in Gilts.
As uncertainty surrounding central banks’ tightening paths shake the market, sovereign bonds with a high beta suffer the most. Italian BTP spiked amid the hawkish recent ECB meeting, for then dropping by 45bps when the BOE didn’t go forward with a rate hike. The ECB’s December meeting is going to be key to set sentiment in the periphery. The PEPP program, which Italy has been the biggest beneficiary of, is going to be ended by March. The performance of BTP depends on the ability of the central bank to convince the market that support will continue to be provided.
In real terms, investment grade corporate bonds yield continue to drop.
Junk bonds total return has dropped following the recent advance of breakeven rates. US HY corporates pay 1.0% in real terms. In Europe, junk pays 0.90% in real terms. In the UK high-yield corporates are offering only 19bps in real terms.
The spread between HY and IG corporate bonds remains flat trading at the lowest level in 14 years. It shows that weaker corporate bonds remain vulnerable to a sudden spike of volatility in rates.
2024: The wasted year
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.
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.
