Fixed income market: the week ahead
Senior Fixed Income Strategist
Summary: The bond market is providing contradictory signals. While nominal rates are biting the "lower for longer" Federal Reserve's message, breakeven rates have fallen amid tapering fears arising from the latest FOMC minutes. This week's ISM Services PMI numbers and nonfarm payrolls provide an opportunity for breakeven rates to resume their rise, reviving the reflation trade. In Europe, the consumer price index will be in focus, and we don't expect it to lead to discussions about tapering among ECB policymakers. Last week's weak 15-year Bund auction shows that European countries need the central bank's support to carry their financing operations. This week's 30- and 50-years OAT auction will be vital to understanding whether appetite for duration continues to deteriorate, causing yields to rise even further ahead of the German election.
The bond market buys “lower for longer” Fed’s message, but breakevens don’t
The market expects the Federal Reserve to hold to their Average Inflation Targeting (AIT) framework despite a sustained rise in inflation data.
It was clear on Friday when yields failed to move, although the core Personal Consumption Expenditures (PCE) data showed an increase of 3.1% YoY, the highest pick up in nearly thirty years. Shortly after, the University of Michigan published their latest survey showing that consumer sentiment and current economic conditions deteriorated since the previous month. It led to a fast drop of yields across the curve, which pushed 10-year US Treasuries back below 1.6%. Investors conclude that if the macroeconomic backdrop doesn’t strengthen, the Federal Reserve will not taper even if inflation gets really hot.
There is a problem with that rationale.
While the market debates concerning the temporary nature of inflation, nobody knows how much inflation will rise and how long for is going to stay high. The recent University of Michigan survey shows that more than half of the respondents expect inflation to sustain above 3% in the next five years. The same study showed that the median for the expected change in prices during the next year is 4.6%. If that were the case, it is unlikely that Fed’s members won’t start looking at inflation with concern, and the dot-plot will need to advance.
Any discussion concerning tapering or moving in the FOMC dot-plot is pivotal for yields to resume their rise. The latest FOMC minutes provoked a fast correction of breakevens as it suggested that members were open to starting discussing tapering. The move contradicts the “lower for longer” Fed’s mantra. Both breakevens and the inflation swap market right now are indicating that tapering talks may be a probable outcome during the next monetary policy meetings.
Tapering talks is not the only factor that may drive yields higher. Indeed, bonds price on inflation expectations rather than on hard inflation data. Thus, if breakeven rates resume their rise, we can expect bond yields to point higher too. That’s why this week’s jobs numbers are in focus. Last month’s nonfarm payrolls miss put the reflation trade on pause. Suppose the employment report exceeds expectations on Friday. In that case, there is the possibility that breakeven rates start to rise, reviving the reflation trade.
The ISM Services PMI out on Thursday is also forecasted to rise in May, putting more pressures on the reflation trade ahead of the NFP numbers.
Europe Focus: CPI numbers and France 30- and 50-year OAT auction
In Europe, the focus will be on inflation numbers, with the Eurozone consumer price index forecasted to rise 1.9% YoY, the highest in three years and close to the ECB target. Even a slight surprise in this number could push yields higher as tapering fears increase. However, we believe tapering fears in the euro area will be premature. Indeed, the European Central bank will be reluctant even to start thinking about pulling support amid today's disappointment in the monetary aggregate M3, which decreased to 9.2% in April from 10.1% in March. The data shows that credit access might be tightening, although the economy is just starting to emerge from lockdowns.
Not only, but last week’s disastrous Bund auction highlighted the necessity of the ECB to continue with its QE programs, including the PEPP, to support countries’ ongoing financing operations. Last week, the German finance agency had to stop the sale of 15-year Bunds amid weak demand, allocating only €1.7 billion out of the €2.5 billion targets. Demand for Italian 5- and 10-year BTPS on Friday was the weakest since the beginning of the year. That's why it will be essential to monitor government bond auction in Europe this week, particularly in France, as the country is looking to sell bonds of various maturities, among which 50-year OAT (FR0014001NN8). The bonds fell roughly 20% since issuances (January 2021). They are currently pricing 75 cents on the dollar, while yields rose from around 0.55% to 1.15%. Bidding metrics at this auction will be vital to understanding whether market appetite for duration continues to fall. If that were the case, it would reinforce our belief that yields in the euro area need to dramatically rise, with the German elections being the biggest catalyst for such change.
The ECB will be reluctant to pull support within this context and will most likely keep current monetary policies unchanged.
Monday, the 31st of May
- Japan: Retail Trade, Industrial Production
- China: Non-Manufacturing PMI, NBS Manufacturing PMI
- Australia: Private Sector Credit
- Eurozone: Private Loans, M3 and M2 Money Supply
- Spain: Consumer Price Index
- Italy: Consumer Price Index
- United Kingdom: 30-year Bond Auction
- Germany: Harmonized Index of Consumer Prices
- Canada: Current Account
Tuesday, the 1st of June
- Australia: Building Permits, Current Account Balance, RBA Interest Rate Decision and Rate Statement
- China: Caixin Manufacturing PMI
- Germany: Retail Sales
- Switzerland: Real Retail Sales
- Spain: Markit Manufacturing PMI
- Italy: Markit Manufacturing PMI, Unemployment
- France: Markit Manufacturing PMI
- Germany: Markit Manufacturing PMI, Unemployment Change, Unemployment Rate
- Eurozone: Markit Manufacturing PMI, Consumer Price Index, Unemployment Rate
- Canada: Goss Domestic Product, Markit Manufacturing PMI
- United States: Markit Manufacturing PMI, ISM Manufacturing PMI, ISM Manufacturing Employment Index, 3- and 6-months Bill Auction
- United Kingdom: BOE’s Governor Bailey Speech
Wednesday, the 2nd of June
- Australia: Gross Domestic Product
- United Kingdom: 10-year Bond Auction, Mortgage Approval, M4 Money Supply
- Germany: 5-year Note Auction
- Eurozone: Producer Price Index
- United States:Fed’s Beige Book
Thursday, the 3rd of June
- Australia: Trade Balance, Retail Sales
- China: Caixin Services PMI
- Japan: 10-year Bond Auction
- France: Markit PMI Composite, Markit Services PMI, 10-, 20-, 30 and 50-year Bond Auction
- Spain: Markit Services PMI, 3-, 5- and 10-year Bond Auction
- Italy: Markit Services PMI
- Germany: Markit Services PMI, Markit PMI Composite
- Eurozone: Markit Services PMI, Markit PMI Composite
- United Kingdom: Markit Services PMI
- United States: ADP Employment Change, Initial Jobless Claims 4-week average, Markit Services PMI, Markit PMI Composite, ESM Services PMI, ISM Service Employment Index, ISM Services Prices Paid
- United Kingdom: BOE Monetary Policy Report Hearings, BOE’s Governor Bailey Speech
Friday, the 4th of June
- Japan: Overall Household Spending
- Eurozone: Retail Sales
- United States: Nonfarm Payrolls, Average Hourly Earnings, Average Weekly Hours, Unemployment Rate, Factory Orders, Powell speech in the BIS Panel on Climate
- Canada: Unemployment Rate, Average Hourly Wages, Labour Productivity, Net Change in Employment
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.