Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
Fixed income market: the week ahead
Althea Spinozzi
Head of Fixed Income Strategy
Summary: It will be an intense week where central banks' monetary policies in the U.S., U.K. and Japan will be in focus. Investors should prepare for US Treasuries to continue to plunge as after last week's auctions, it's clear that foreign investors' demand is not picking up yet. To add pressure to Treasuries are higher inflation expectations, which saw the 5-year breakeven rate rising to the highest level since 2008, and news related to the Covid-19 vaccination's pace. In the U.K., we expect Gilt yields to continue their rise towards 1% as BOE will maintain its positive stance. We remain cautious sovereigns from the periphery as new lockdown measures are introduced. The gap in yields between European government bonds and U.S. Treasuries continues to grow, making the periphery vulnerable to a possible rotation.
Federal Reserve’s meetings always absorb the market's attention; however, this week, it will be a central event for all asset classes as bearish sentiment continues to be prevalent within US Treasuries. After last week’s bond auctions, it is clear that foreign investors are not rushing to buy into US Treasuries, leaving bonds vulnerable to a further selloff as reflationary and economic growth expectations grow. That doesn’t mean that foreign investors have given up on US Treasuries; however, they might be waiting for the right moment to enter, which is likely to be around 2% in 10-year yields. The Federal Reserve will soon need to decide whether to extend the emergency capital relief for big banks beyond the end of March. At the moment, the Supplementary Leverage Ratio (SLR) break represents an important source of demand for US Treasuries. The risk is that if the Fed doesn't extend such relief, banks will need to buy fewer Treasuries adding to the current bond market weakness.
Tomorrow the US Treasury will issue 20-year Bonds, while on Thursday, it will follow up with a 10-year TIPS auction. It will be important to monitor the bidding metric pre-and-post-FOMC meeting to understand better whether demand improves after the Fed interest rate decision.
To add to US Treasuries’ bearish sentiment is the rise in inflation expectations. Last week, the 5-year breakeven rate rose to the highest level since 2008, hitting 2.57%, meaning that the market expects any return provided by US Treasuries to be eroded by inflation. Inflation expectations will continue to rise as good news comes from Covid-19 vaccination's speed. Biden said that all adults in the United States would be eligible for a vaccine by May the 1st.
To keep the market busy will also be the monetary policy decisions coming out from the Bank of England and the Bank of Japan.
Before Wednesday’s BOE’s meeting, Boris Johnson unveils the United Kingdom's foreign and Defense policy, which would most likely see it diverge from the one of the European Union, especially for when it comes to China. Such a decision will align the country more closely to the United States.
However, in the bond market, the biggest focus will be on the central bank's approach to rising interest rates, which has been completely dismissed until now. Andrew Bailey said that the rise in yields is reflecting the optimism in the country's economy. On top of it, in a recent interview, the Bank’s financial stability chief Alex Brazier said that the quantitative easing program represents a potential risk to the U.K. economy.
If these are the hawkish stances that the BOE will maintain on Wednesday, we can expect yields to resume their rise towards 1% in 10-year Gilts. We are still of the idea that if yields rise too fast, such as they did since February, preceding an economic recovery, the BOE will have no other alternative than to intervene to slow them down. Although the U.K. economy is set to recover, financial conditions need to remain easy to avoid market turmoil.
The Bank of Japan monetary policy decision on Friday is also key for bond traders. Kuroda will explain the results of his comprehensive review of the Bank's monetary policy. The goal will be to add flexibility to its yield curve control policies. Investors have been wary of buying Japanese Government Bonds (JGB) before this week's meeting, and 10-year JGB's yields are trading now slightly above 0.1%. It leaves room for a small rally as the central bank reinforces its message to anchor the 10-year JGB yield around 0% but accepting a certain degree of fluctuation in long-term interest rates.
In Europe, the market will pay attention to new lockdown measures, which are starting to be imposed ahead of Easter. Italy is a focus as infections are rising amid more-contagious strains from the U.K. and Brazil. This will leave sovereigns from the periphery vulnerable to a selloff in light of rising yields in the United States. As explained in our analysis published last week, US Treasuries with 10 years maturity hedged against the euro offer around 0.8% in yield, which is around the same yield 10-year Greek sovereigns offer. As yields continue to rise in the US, we can expect investors to rotate from the periphery to the US safe heavens, especially in countries with a high percentage of foreign investment, such as Greece and Portugal.
Economic calendar:
Monday, the 15th of March
- Eurogroup meeting
- China: Industrial Production, Retail Sales
- Australia: HIA New Home Sales
Tuesday, the 16th of March
- New Zealand: Westpac Consumer Survey
- Australia: RBA Meeting Minutes, House Price Index
- Japan: Industrial Production
- Eurozone: Ecofin Meeting, ZEW Survey – Economic Sentiment
- Germany: ZEW Survey – Economic Sentiment and Current Situation
- United States: Retails Sales, 20-year Bond Auction
Wednesday, the 17th of March
- Australia: RBA’s Kent speech, Westpac Leading Index
- Japan: Merchandise Trade Balance
- Eurozone: Consumer Price Index
- Germany: 30-year Bond Auction
- United States: Building Permits, FOMC Economic Projections, FED Interest Rate Decision and Monetary Policy Statement, FOMC Press Conference
- Canada: BOC Consumer Price Index
Thursday, the 18th of March
- New Zealand: Gross Domestic Product
- Australia: Employment Rate
- Eurozone: Labor Cost
- France: 3-, 5- 7-year Bond Auctions
- United Kingdom: BOE Interest Rate decision, BOE Asset Purchase Facility, BOE’s Haldane speech
- United States: Continuing Jobless Claims, Philadelphia Fed Manufacturing Survey, 10-Year TIPS Auction
Friday, the 19th of March
- Japan: National Consumer Price Index, BOJ Monetary Policy Statement and Interest Rate Decision
- United Kingdom: GFK Consumer Confidence
- Australia: Retail Sales
- Canada: Retail Sales
- Germany: Producer Price Index
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