Fixed income market: the week ahead

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.

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 25^th, driving sentiment for the whole periphery before the ECB interest rate decision.

Economic Calendar

Monday, the 8^th 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 17^th

Tuesday, the 9^th 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 10^th 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 11^th 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 12^th 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