Fixed income market: the week ahead

Bonds
Althea Spinozzi

Senior Fixed Income Strategist

Summary:  Prepare for an intense week in which the issuance of 10- and 30-year bonds will test appetite for US Treasuries just after the Consumer Price Index data release. As US Treasury yields continue to rise, pushing up high-grade corporate bonds' yields, the rotation from stocks to bonds becomes more and more compelling. Be wary of the 1.65% level in 10-year yields, which has the potential to trigger another squeeze within the Mortgage-Backed Security (MBS) market, setting yields on a fast track to 2%. In Europe, the focus will be on the European Central Bank's bond purchases data released today and the central bank's monetary policy meeting on Thursday. Italy is to test the market's appetite for BTPs for the first time since the weak 5-year bond issuance on February the 25th, driving market sentiment in the periphery ahead of the ECB's interest rate decision.


This week the bond market has plenty of reasons to continue the selloff it started last week. Last Thursday, Jerome Powell predicted an increase in consumer prices this summer. Still, he remained dovish, stressing that we are far away from maximum employment and long-term inflation. The Secretary of the US Treasury, Janet Yellen, also downplayed the rise in yields on Friday saying that they signal a recovery. Mrs Yellen even added that the $1.9 trillion fiscal stimulus package is not excessive. These statements lead the market to take direct control of monetary policies pushing yields higher. For the first time since February last year, the yield on 10-year US Treasury Bonds closed above 1.5%. We believe that this week there is scope for yields to continue their rise, and if they get close to 1.65% level, we might witness another squeeze within the Mortgage-Backed Security (MBS) market, which could send yields on a fast track to 2%.

Catalysts for such a selloff could be Wednesday’s inflation numbers preceding the 10- and 30-year US Treasury bond auctions. Although the Treasury’s auctions are often uneventful, the ones coming up this week could prove interesting. A couple of weeks back, the 7-year note auction tailed by 4.2 basis points, the most in the auction's history. Even more worrying, foreign demand dropped dramatically, with indirect bidders plunging to the lowest since 2014 from 64.10% to just 38.06%. Foreign demand for US Treasuries is crucial to support the considerably large bond issuance in light of higher government spending. If foreign demand lingers, the selloff in US Treasuries could intensify considerably, leaking to other assets. Today’s release of the Treasury auction allotment of the 20-year note auction of February 17th will be key to preparing for this week's auctions as it will give a snapshot of the demand for long-term Treasuries. Unfortunately, the auction allotment for the recent 7-year note auction will not be released until March the 22nd.

Source: Bloomberg.

Developments in the bond market are key for risky assets' performance, too, particularly for the stock market. As Treasury yields rise, not only a higher discount rate will be applied to future expected corporate's earnings, but the relative advantage to hold overvalued stocks trading over 25x P/E ratio versus holding bonds is going to narrow. Indeed, while the option-adjusted spread (OAS) of US corporate bonds remains the tightest in twenty years, their yield to worst (YTW) started to rise together with US Treasury yields. While at the beginning of the year, high-grade corporate bonds were providing an average YTW of 1.75%, now they pay around 2.2% YTW. If the yield on investment-grade (IG) corporate bonds continue to rise, the rotation from stocks to bond will become more and more compelling as investors will be able to secure a good return, by investing in safer assets while avoiding any turmoil in the stock market. We believe that we will see such rotation as the US 10-year Treasury yield nears 2% and the average yield of US IG corporate bonds rises to 2.75%, the minimum YTW this asset class has been providing in the past seven years.

Meanwhile, junk bonds will continue to be supported for the simple reason that right now, amid economic recovery and rising inflation expectations, high yield corporate bonds are the only assets to offer a buffer against rising yields. Only when the high-grade corporate space will become a real alternative to stocks, as highlighted above, we will see the market reassessing risk provoking a widening of high yield corporate spreads tightening financial conditions considerably.

Source: Bloomberg.

We remain of the opinion that ultimately the Federal Reserve will have no other choice other than engaging in Yield Curve Control (YCC) when 10-year yields will get close to the pivotal 2%. Powell's speech last week was clear in saying that Federal Reserve will intervene to stop disorderly markets and the tightening of financial conditions making YCC very likely despite a booming economy scenario. This behaviour could lead to a severe monetary policy mistake.

In Europe, the market will focus on the ECB’s bond purchases data that are going to be released today to understand whether the central bank is acting on its promises to keep European sovereign bond yields in check. If the report disappoints, we might be facing another week of a selloff in European government bonds that will most likely stall with the ECB Interest Rate Decision and Press Conference on Thursday. We believe that a temporary increase of the PEPP’s pace is likely, which could focus on bonds of those more volatile countries, given the lack of collateral that the Euro area is suffering from.

Before the ECB monetary policy meeting on Thursday, it will be important to monitor Italy’s 3- and 7-year notes auctions as the recent 5-year BTP auction registered the lowest bid-to-cover ratio since June amid the selloff in European sovereigns. Last week, Italy’s green bond issuance attracted more than 80 billion euros in bids; however, it's important not to commit the mistake to compare such issuance with traditional BTP issuances. Indeed, last week's green bond was a debut for Italy in this space, coming at a time when the supply of these instruments continue to be limited while the green bond investors base continues to grow. On Thursday, Italy will test appetite for traditional BTPs for the first time since the weak 5-year Bond auction of February the 25th, driving sentiment for the whole periphery before the ECB interest rate decision.

Economic Calendar

Monday, the 8th of March

  • Japan: Leading Economic Index
  • Switzerland: Unemployment Rate
  • Germany: Industrial production
  • United Kingdom: BOE’s Governor Bailey Speech
  • United States: Treasury Auction Allotment data for the 20-year note sale on February 17th

Tuesday, the 9th of March

  • Japan: Overall Household Spending, Gross Domestic Product
  • Australia: New Home Sales
  • United Kingdom: BRC Like-for-like retail sales
  • Germany: Trade Balance
  • Europe: Gross Domestic Product
  • United States: US Treasury Sells 3-year Notes

Wednesday, the 10th of March

  • Australia: RBA’s Governor Lowe Speech, Westpac Consumer Confidence
  • China: Consumer Price Index, FDI – Foreign Direct Investment
  • United States: Consumer Price Index, US Treasury Sells 10-year Notes
  • Canada: BOC Rate Statement, Interest rate Decision

Thursday, the 11th of March

  • Australia: Consumer Inflation Expectations
  • Switzerland: SECO Economic Forecast
  • Italy: 3- and 7-year Bond sales
  • Eurozone: ECB Interest Rate Decision and Press Conference, US Treasury Sells 30-year Notes
  • United States: Continuing Jobless Claims
  • Bank of Canada: BOC’s Schembri Speech

Friday, the 12th of March

  • United Kingdom: Industrial Production, Gross Domestic Product, NIESR GDP Estimate, Manufacturing Production
  • Germany: Consumer Price Index
  • Eurozone: Industrial Production
  • United States: Producer Price Index, Michigan Consumer Sentiment Index
  • Canada: Unemployment Rate, 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 and a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed here or 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.