Fixed income market: the week ahead Fixed income market: the week ahead Fixed income market: the week ahead

Fixed income market: the week ahead

Althea Spinozzi

Head of Fixed Income Strategy

Summary:  The probability for the Federal Reserve to announce an immediate end of purchases as soon as next week is rising. If that were happening, it would open up the way to a first interest rate hike in March and an announcement of the balance sheet runoff as soon as June. We expect the yield curve to continue to bear-flatten until a clear communication surrounding the balance sheet reduction. Depending on how aggressive it will be, long-term rates can increase considerably. In Europe, the ECB minutes for December will be in the spotlight as concerns regarding high inflationary pressures surge among policymakers.

US Treasuries: what a shrinking balance sheet means for yields?

US Treasury yields resumed their rise last Friday as the US Treasury sent its quarterly survey of primary dealers asking their views on how a Federal Reserve balance sheet runoff might impact its financing needs and issuance decisions. Ten-year US Treasuries rose by 7bps to 1.78%, aiming to their resistance level at 1.8%, first tested last Monday since January 2020, but rejected. The short part of the yield curve also rose, with 2-year yields rising quickly to 0.96%, the highest since February 2020 and close to the pivotal 1% level.

Source: Bloomberg and Saxo Group.

Investors are starting to resonate with the idea that the Federal Reserve will need to complement the imminent interest rate hiking cycle with a reduction of the balance sheet to fight sustained inflation levels. In that case, long-term yields will rise together with short-term yields, tightening the economy more proactively. Indeed, mortgages and borrowing costs are impacted by 10-year yields rather than short-term rates. Therefore, a rise in long-term yields is necessary if the Fed wants to cool off the economy.

Additionally, a balance sheet runoff might enable the Fed to be less aggressive with interest rate hikes, letting the yield curve do a lot of the heavy lifting. At that point,  there might not be a need to hike interest rates five times, as Waller recently suggested. It might be possible to limit them to three, catering for a gradual tightening and avoiding the yield curve to further flatten from now. The 2s10s spread is around 80bps, while the 5s30s spread trades at 55bps. Rapid interest rates hikes might lead the yield curve to an inversion, which historically has been a strong indicator of future recessions. It makes sense that the Federal Reserve wants to reduce such risk to a minimum and looks to use all the tools in its power to get a steeper yield curve. 

Source: Bloomberg and Saxo Group.

Despite making sense for the Federal Reserve to begin talking about a balance sheet reduction, the market remains on hedge because it’s unsure about the consequences.

The last time the Fed announced it would allow maturing assets to run off the balance sheet was in June 2017, 18 months after the Fed raised interest rates. This time around, Fed officials are talking about interest rate hikes and shrinking the balance sheet in the same year, making a case for higher yields more robust.

Another point needs to be highlighted: if the Fed is looking to shrink its balance sheet already in 2022, why does it continue to expand it? It doesn’t make sense! That’s why there is a possibility that during January’s FOMC meeting, the Fed announces an immediate termination of purchases. With bond purchases ceasing this month, The Fed opens up the way for an interest rate hike already March, followed by an announcement of the balance sheet runoff as soon as in June.

An early end to tapering this month would make sense also under the perspective that the US Treasury will cut its bond issuances as fiscal needs have diminished sensibly compared to the 2020 and 2021 pandemic years. Thus, demand for bonds should continue to remain supported, limiting volatility.

It is not easy to say how high long-term US Treasury yields can go. Indeed, a lot will depend on how aggressive the balance sheet's runoff will be. In 2017,  the amount of assets allowed to runoff was initially capped at $10bn per month in total for Treasuries and Mortgage-Backed Securities and gradually increased. The Fed might want to adopt the same strategy or, it might need to be more aggressive depending on how many times it will need to raise interest rate hikes this year.

Additionally, as we pointed out last week, demand for US Treasuries will increase as yields rise. Many investors are still locked in ultra-low yields globally. The US safe-haven can still provide a pick-up over global benchmarks once hedged against FX risk. As an example, EUR-hedged 10-year US Treasuries provide 92bps above the German Bunds.

Therefore, it is safe to assume that the rise in long-term yields will be contained until more details will surface concerning the Fed's balance sheet runoff. In contrast, the front part of the yield curve will continue to rise on the expectations of faster and aggressive interest rate hikes. Thus, we expect a bear flattening of the yield curve to continue.

This week, Fed officials have no scheduled appearance as they have entered the quiet period preceding the FOMC meeting. Yet, it is a week packed with economic data such as the Empire State manufacturing index, Building Permits, and the Philly Fed manufacturing index. We do not expect these data to alter market expectations of an interest rate hike by March. On Wednesday, we have a 20-year US Treasury auction worth following. The 20-year tenor is not as popular as the other, and lack of demand could cause volatility in the long part of the yield curve.

European sovereigns: ECB minutes and inflation.

After European sovereign yields dropped suddenly last week with 10-year Bund yields testing support at -0.10%, today they look once again on the rise. The market has started to price an ECB interest rate hike as early as October. On Thursday, the ECB will release its monetary policy meeting accounts, showing how worried officials are about inflation upside risk, influencing hiking expectations. On the same day, a second reading on euro-area consumer prices will be released, which preliminary data showed to have jumped to 5%.

Sovereign bond issuance continues this week with Germany selling 5-year and 15-year bonds, France selling 3-year, 5-year, and 7-year Notes, Spain selling 5-year, 8-year, and 18-year Bonds.

We expect bidding metrics to remain sustained in European sovereign auctions; however, volatility will remain high amid fading ECB support and higher yields in the US. We expect sovereigns with the highest beta, such as Italy, to be more vulnerable.

Source: Bloomberg and Saxo Group.

Economic calendar:

Monday, January the 17th

  • China: Gross Domestic Product (Q4), Industrial Production (Dec), NBS Press Conference, Retail Sales (Dec)
  • Italy: Consumer Price Index (Dec)
  • United Kingdom: NIESR GDP Estimate (Dec)
  • Canada: Bank of Canada Business Outlook Survey

Tuesday, January the 18th

  • New Zealand: REINZ House Price Index (Dec), NZIER Business Confidence (Q4)
  • Japan: BOJ Interest Rate Decision, BOJ Monetary Policy Statement, BOJ Outlook Report, and Press Conference, Industrial Production
  • United Kingdom: Average Earnings (Nov), Claimant Count Rate (Dec), ILO Unemployment Rate (Nov)
  • Eurozone: ZEW Survey – Economic Sentiment (Jan)
  • Germany: ZEW Survey – Economic Sentiment (Jan), ZEW Survey – Current Situation (Jan), 5-yer Note Auction
  • United States: NY Empire State Manufacturing Index (Jan), NAHB Housing Market Index (Jan), 3-month and 6-month Bill Auction

Wednesday, January the 19th

  • Australia: HIA New Home Sales (Dec)
  • United Kingdom: Consumer Price Index (Dec), PPI Core Output (Dec), Producer Price Index (Dec), Retail Price Index (Dec)
  • Germany: Harmonized Index of Consumer Prices (Dec), 15-year Bond Auction
  • Eurozone:  Current Account (Oct), Construction Output (Nov)
  • United States: MBA Mortgage Applications (Jan 14), Building Permits (Dec), 20-year Bond Auction
  • Canada: BoC Consumer Price Index

Thursday, January the 20th

  • Australia: Westpac Consumer Confidence (Jan), Consumer Inflation Expectations (Jan), Employment Change (Dec), Unemployment rates (Dec)
  • Japan: Merchandise Trade Balance (Dec), Exports and Imports (Dec)
  • China: PBoC Interest Rate Decision
  • Germany: Producer Price Index
  • France: 3-year, 5-year, and 7-year Bond auctions
  • Spain: 5-year, 8-year, and 18-year Bond Auctions
  • Eurozone: Consumer Price Index (Dec), ECB Monetary Policy Meeting Accounts
  • United States: Initial Jobless Claims (Jan14), Philadelphia Fed Manufacturing Survey (Jan), 4-week Bill Auction

Friday, January the 21st

  • New Zealand: Business NZ PMI (Dec)
  • Japan: National Consumer Price Index (Dec), BOJ Monetary Policy Meeting Minutes
  • United Kingdom: GfK Consumer Confidence (Jan), Retail Sales (Dec)
  • Canada: Retail Sales (Nov)
  • Eurozone: Consumer Confidence (Jan)

The Saxo 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 is not intended to and does not change or expand on this. 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 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 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 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 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 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 (
- Full disclaimer (

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.