Fixed income market: the week ahead

Fixed income market: the week ahead

Bonds
Althea Spinozzi

Senior Fixed Income Strategist

Summary:  This week's focus will be on the FOMC minutes. The report could show growing divergence concerning the transitory nature of inflation among members, pushing forwards tapering expectations. The summer lull will keep US Treasury yields rangebound. However, August will be pivotal as there are increasing doubts regarding an extension of the debt ceiling's suspension, and the Treasury is preparing for a drawdown of the Treasury General Account (TGA). Elements are indicating that either the Federal Reserve needs to accept negative T-Bill yields or taper aggressively. We believe the second to be the most probable outcome. Thus, mid-term, we expect the US yield curve to continue to bear-flatten as the Fed engages more aggressively in tapering talk. Yet, yields will shift higher as inflationary pressures begin to look less transitory in autumn. In Europe, the focus is on the ECB's special strategy meeting, which could extend its accommodative monetary policies.


Dear reader, this will be the last Fixed income the week ahead before the summer break. I will finally go to Italy after more than a year of Danish confinement to get plenty of pasta, pizza and sun. The week ahead will resume on the second half of August. However, I will be returning at the end of the month for our regular monthly Fixed Income Update webinar. You can sign up by clicking on it here.

While many of us are heading towards a well-deserved vacation, the market is yet to pack its bags. Friday’s strong nonfarm payrolls failed to revive the reflation trade as the report gave contradictory messages. Jobs grew together with the unemployment rate. Wages increased the most since the Global Financial Crisis of 2008/09, but working hours fell. It’s clear that although the job market is recovering, we are still far away from the Fed’s full unemployment target. Hence, the market expects the central bank to continue to remain accommodative.

Yet,  we believe that investors are misreading the central bank message. While the full employment vision has dominated monetary policies since the Covid-19 pandemic, the last FOMC meeting sent contradictory messages. The Federal Reserve hiked interest rates in two key money market facilities and opened up to tapering despite jobs numbers missed expectations for two months in a row. We believe it is clear that the central bank is shifting its focus from jobs to inflation pressures.

Therefore, this week's minutes will be critical as they may give an idea of whether FOMC members are starting to be less confident about inflation's transitory nature and when the Fed could begin tapering its asset purchases. Regardless, US Treasury yields will most likely continue to trade rangebound until the Federal Reserve begins to engage more actively with tapering talks.

Excess liquidity, the resumption of a debt ceiling limit, and the Treasury General Account drawdown will continue to squash US Treasury yields. We may be facing T-Bills paydowns (when the government issues less debt than what is maturing), which, combined with a reduction of the TGA, translates into lower yields in the front part of the yield curve. Because T-Bills are already close to 0%, the Federal Reserve will soon need to decide whether to accept negative yields in the front part of the yield curve or to taper more aggressively than the market anticipates.

Concerns regarding a spike in volatility are rapidly growing. Money market guru Zoltan Pozsar begins to be troubled about the growing size of the Fed’s Reverse Repurchasing Facility (RRP). According to him, the sudden surge of RRP usage following the 5bps hike from the Federal Reserve implies that a large part of cash is rotating from bills to the RRP facility. However, T-Bills demand is crucial for future issuances. Zoltan says that the RRP is becoming an "active tool that sucks the deposits away that banks decided to retain”.

How does all the above come to play for bond investors? Everything is pointing to a negative T-Bills rate in the short term and a bear flattening of the US yield curve in the mid-term. It doesn't mean that long term yields will continue to fall. They might fall and break below 1.40% in the short-term, finding support next at 1.20%. Yet, as inflationary pressures become less transitory, we might see the yield curve shifting higher while bear-flattening.

Source: Bloomberg and Saxo Group.

The ECB special strategy meeting might pave the way to more accommodative monetary policies

As I am wrapping up for summer, the European Central Bank has decided to hold a special meeting in Frankfurt to finalize its strategy review, which began before the Covid pandemic. A broad range of topics will be discussed during this meeting, ranging from inflation, employment, climate change, and fiscal policy. The focus will be whether the ECB is leaning towards looser monetary policies as broad consensus show that the current inflation target of “below, but close to, 2%” should be replaced.

During the June 28-20 gathering, reports were saying that it was a general consensus that the ECB should tolerate inflation exceeding the current target. Thus, it opens up the possibility that the central bank might adopt a framework similar to the Fed's Average Inflation Targeting (AIT), which will enable looser monetary policies amid a temporary rise of inflation. Yet, Chief Economist Philip Lane said that he’s not willing to mimic the Fed. Therefore, the ECB might opt to change its inflation target to 2% as most developed central banks.

The discussion could shape ideas on exiting the PEPP program, which is set to be terminated in March 2022. Austria's Holzmann and German Weidmann last week were vocal about the guaranteed termination of the PEPP program next year. Bundesbank’s Weidmann even mentioned that the central banks should consider taper ahead of March to avoid any market shock.

Regardless of the above, we expect European sovereigns to continue to trade rangebound until the German election unless yields resume their rise in the United States. Indeed, it will be unlikely that the ECB will change its stance before the German election. However, things can quickly change in the fall as a new German government should bring about higher bond yields amid higher fiscal spending plans and better European integration. Higher yields imply tighter financing conditions. Therefore if the ECB moves too early, there is the risk that the conditions would tighten even faster.

Economic Calendar:

Monday, July the 5th

  • Australia: Building Permits, Retail Sales
  • China: Caixin Services PMI
  • France: Industrial Output, Markit Services PMI, Markit PMI Composite
  • Spain: Markit Services PMI
  • Italy: Markit Services PMI
  • Germany: Markit Services PMI, Markit PMI Composite
  • Eurozone: Markit Services PMI, Markit PMI Composite, Sentix Investor Confidence
  • United Kingdom: Markit Services PMI

Tuesday, July the 6th

  • Japan: Overall Household Spending
  • Australia: RBA Interest rate Decision and Statement, RBA’s Governor Lowe speech
  • Germany: Factory Orders, ZEW Survey- Current Situation and Economic Sentiment
  • Eurozone: ZEW Survey – Economic Sentiment, Retail Sales, Economic Commission releases Economic Growth Forecast
  • United Kingdom: 10-year Bond Auction
  • United States: Markit Services PMI, Markit PMI Composite, ISM Services New Orders Index, ISM Services PMI, ISM Services Employment Index, ISM Services Prices Paid

Wednesday, July the 7th

  • Japan: Leading Economic Index
  • Germany: Industrial Production, 5-year Bond sale
  • France: Trade Balance
  • Italy: Retail Sales
  • Canada: Ivey Purchasing Managers Index
  • United States: FOMC Minutes, Fed Monetary Policy Report

Thursday, July the 8th

  • Australia: RBA’s Governor Lowe speech
  • Switzerland: Unemployment Rate
  • Germany: Trade Balance
  • Eurozone: ECB Special Strategy Meeting
  • United States: Initial Jobless Claims

Friday, July the 9th

  • China: Consumer Price Index
  • United Kingdom: Manufacturing Production, Industrial Production, Gross Domestic Product, NIESR GDP Estimate
  • Italy: Industrial Output
  • Canada: Unemployment Rate, Net Change in Employment, Participation Rate, Average Hourly Wages

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research 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. To the extent that any content is construed as investment research, you must note and accept that the 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 under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
Beethovenstrasse 33
CH-8002
Zurich
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved we have put together a general Risk Warning series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law.

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.