Senior Fixed Income Strategist
Summary: This week, the reflation trade will be in focus as 10- and 30-year US Treasury yields closed last week above their resistance level. It will be essential to monitor the release of the FOMC minutes as any mention of tapering might be a setback for rising yields. The 30-year TIPS auction on Thursday will also be important as it will test the market's appetite for inflation hedges. This morning, European bonds are selling off in response to last week's rising US yields. Gilts are leading losses as the country reached 15 million COVID-19 jabs milestone, and yields are moving towards their 0.65% resistance level. On Wednesday, the UK sells 2057 Gilts. It's crucial to watch out for any signs of duration indigestion as it could add pressure to already rising yields. Once the selloff in EU sovereigns settles, spread compression in the periphery will resume as Draghi strengthens his position in Italian politics.
This morning the European bond market is opening lower as stocks gains. Gilts and Bunds are leading losses with 10-year yields rising by 7 and 4.5 basis points respectively. The German yield curve is bear steepening with the 2s10s Bund spread rising to the widest level since June 2020 in response to the reflation trend seen last week in the US. On the other hand, Gilts are selling off as the UK is rolling out COVID-19 jabs faster than any other country in Europe.
Although sovereign bonds from the periphery are selling off together with their peers, they prove more resilient. The periphery is still benefitting from the entrance of Mario Draghi in Italian politics. Once the selloff in European sovereigns settles down, we will most likely see spread compression in the periphery resuming. Since Giuseppe Conte resigned at the end of January, Italian government bonds across the board rose by 1% in value. Still, long-term bonds provided the most significant upside with the benchmark 30-year BTP increasing 2% in value. The ten-year BTP-Bund spread tightened to 90 basis points to the lowest level seen since 2010. Some analysts are calling for it to tighten to 25bps, the same level BTPs were trading relative to their German peers before the Global Financial Crisis of 2008. The tightening of the spread between BTP-Bund was a trend well-established way before Draghi entered Italian politics, but he accelerated it massively as concerns of anti-European sentiment in Italian politics were put to rest once and for all until the next elections. On one side, it is a unique opportunity for investors to maximize convexity to take advantage of quickly falling interest rates. On the other, the Italian Treasury can take advantage of the positive momentum to issue ultra-long sovereigns. Last week's auctions of 2-, 7- and 20- BTPs showed that market appetite remains solid. It may be the perfect moment to issue a new 50-year BTP which in our opinion would price just a few basis points above the current 50-year benchmark with maturity 2067. We believe that current market conditions enable Italy to test new ultra-long maturities such as 100-years. On the back of the centenary issuance that we have seen from Austria and Ireland, Italy centurion bond would offer roughly 2.5% in yield, making it the highest yielding euro bond issuance after Mexico, which is now offering 3.3% in yield. If you would like to learn about it, click here.
Going back to the United Kingdom, 10-year Gilts opened with a yield of 0.58%, six basis points higher than Friday's close, and the highest since March last year. Suppose positive sentiment continues, and yields sustain trading above 0.55%. In that case, they will find resistance next at 0.65%, a level previously seen at the beginning of 2020. This Wednesday and Thursday Consumer Price Index, Retail Price Index and GfK Consumer Confidence release will affect Gilts' sentiment. Key government bond auctions ahead are the issuance of 2057 and 2035 Gilts on Wednesday and Thursday.
We are heading towards a pivotal week across the Atlantic as last week 10- and 30-years Treasuries closed slightly above their resistance level at 1.2% and 2% hitting a new high despite a soft report on consumer prices. The reflation trade is gaining steam amid expected additional fiscal stimulus and acceleration in vaccine rollout. This week's FOMC minutes will be in the spotlight as any mention of tapering or concerns regarding a fast rise in US Treasury yields could represent a setback for the reflation trade. More importantly, on Thursday, the Treasury will issue $9bn 30-years TIPS, testing the market's appetite for inflation hedges.
Looking at the chart below, we find that once 10-year yields sustain trading above 1.2%, they will find resistance next on their older support line, which now serves as resistance at 1.3%.
Economic Calendar:
Monday the 15th of February
Tuesday the 16th of February
Wednesday the 17th of February
Thursday the 18th of February
Friday the 19th of February
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
