Head of Fixed Income Strategy
Summary: This week, we might see a consolidation of sovereign bonds worldwide as central banks look to stop their rout. Yet, Treasuries' bearish trend has been established, and we expect the consolidation to be only temporary. In the United States, the Covid-19 stimulus bill, Powell's speech on Thursday and Nonfarm payrolls on Friday will be in the spotlight. Many highlight that if ten-year yields break above 1.65%, we might see another squeeze within Mortgage-Backed Securities holders, pushing yields fast towards 2%. Across the Atlantic, European investors remain in the hands of the European Central Bank. The market will be looking at the latest bond-buying figures today to understand whether the pledge to cap yields is real. In the United Kingdom, Rishi Sunak's budget on Wednesday and Thursday's 10-year Gilt auction might provoke yields to resume their rise.
This week will be all about rates. Despite the selloff in US Treasuries last week looked to be over already by Friday, in the next few weeks yields might continue to rise as the $1.9 trillion Covid-19 package heads to the Senate for approval after being passed by the House of Representative on Saturday. Last week Mortgage-Backed Securities (MBS) holders engaged in convexity hedging triggering a fast selloff in Treasuries pushing yields to the highest level in a year. Many highlight that 1.65% is another key level and that if 10-year yields break above it, there is the probability of another squeeze among MBS. As a consequence, we might see yields rising fast towards 2%.
Besides Biden’s stimulus Bill, it will be important to listen to the various Federal Reserve speakers to understand whether the rise in yields worries some of them. The most important speech of the week will be delivered by Powell himself on Thursday when he will discuss the US Economy. Although so far the Fed didn’t’ blink at the rise in Treasury yields, we believe that if the selloff continues, the central bank will not be able to ignore it any longer. Indeed, while it is not worrying that yields rise amid an economic recovery, it's important they don't precede growth and full employment. We believe that nominal yields are rising too fast, with real yields unequivocally putting pressure on the corporate world.
Although last week’s rise in interest rates polarized market attention, we believe that something even more troubling happened: the correlation between Treasury yields and junk bonds returns turned negative, signalling that a selloff in junk credits may be next. Within fixed income, high yield corporate bonds have outperformed other instruments year to date. While junk went up by 0.7% year to date, investment-grade credits fell by 3%. Their performance can be explained by the fact that investors have been buying into junk to create a buffer against rising yields and inflation expectation, which is something that investment-grade bonds cannot provide given the record low yields and their long duration. We believe that if the Federal Reserve doesn’t cap the rise in Treasury yields, risky assets' performance will be at risk. A junk bond selloff would quickly leak to other asset classes such as stocks putting at peril the overall market exactly as we have experienced during 2013 during the Taper Tantrum.
Across the Atlantic, the European Central Bank will need to prove its intention to cap the rise in yields by increasing its QE purchases, and we will know that today as the central bank publishes the latest bond-buying figures. The ECB's problem is that, while monetary and fiscal policies go hand in hand in the United States, Europe lacks fiscal help. The money agreed under the Next Generation EU Recovery Plan last year still needs to be disbursed, and another fiscal package will not come about this year as Germany is going through elections. This leaves the ECB alone in supporting and stimulating the European economy. That's why a sustained selloff in European sovereigns might tighten EU financial conditions putting in peril the central bank's efforts. Today ECB’s President Lagarde speaks, and it's imperative to understand whether the central bank is ready to do whatever it takes to rescue the euro area. If her words are not convincing enough, we might be headed to another week of selloff, which might become expensive for countries issuing long-term bonds this week such as Germany, Spain and France. Spain is running the risk to see a choppy 7-, 10- and 15-year government bond auction on Thursday. Bidding metrics for the periphery's long-term bonds have not been consistent since the beginning of the year. If the ECB fails to turn market sentiment by Thursday, bearish sentiment might leak from the primary to the secondary market and provoke even a deeper selloff of sovereigns within the periphery.
In the United Kingdom, the market is waiting for Rishi Sunak’s Budget announcement on Wednesday, which many expect to unveil a GBP 5 billion grant scheme. Such an announcement could push Gilt yields to break above their resistance line at 0.85% that will inevitably see them rising fast towards 1%. The year-to-date rise in yields has been impressive in the UK, with 10-year yields rising by 60 basis points. Despite Bank of England's speakers seem not concerned about the imminent rise in yields as they attribute it to good news from strong growth expectations, we believe that if 10-year Gilts break above 1%, the central bank might need to reconsider its position. The rise in yields has preceded an economic recovery, and Governor Bailey recently explained that economic data for the first quarter of the year would not be encouraging. Besides Sunak's Budget, Thursday's 10-year Gilt auction will be key to setting Gilts' path towards 1%.
Economic Calendar
Monday, the 1st of March
Tuesday, the 2nd of March
Wednesday, the 3rd of March
Thursday, the 4th of March
Friday, the 5th of March
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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.
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