Fixed income market: the week ahead

Bonds
Althea Spinozzi

Fixed Income Strategist

Summary:  Tomorrow's Georgia run-offs will be incredibly important for the bond market because their result can add to the case for reflation. The 10-year Breakeven rate is the highest in two years, and the US yield curve continues to bear steepen. Eventually, 2021 could be the fifth year in more than forty years in which US Treasuries will provide a negative annual return. In Europe, an extension of lockdown measures might boost European sovereigns' sentiment as the market expects more ECB stimulus. In the UK, Wednesday BOE's governor Bailey's speech might provide an insight into the possibility of negative interest rates.


Dear readers, Happy New Year! It won't come to a surprise to know that 2021 still looks very much like 2020. The risk of running into reflation, Brexit and the Covid-19 pandemic, remain topics that cannot be ignored yet.

Starting with the US, bond investors will need to pay attention to tomorrow's Georgia run-offs to determine whether Republicans or Democrats will take control of the Senate. A Democratic Senate will enable Joe Biden to enact comprehensive legislation on the economy, healthcare and the environment as proposed during his presidential campaign. In short, it implies a bigger stimulus package that will add to the already implemented measures, putting more pressure on inflation.

Consistent with the reflation story, the market expectations on inflation are the highest in two years. The ten-year breakeven is about to touch 2%, and the yield curve continues to bear steepen.

The reflation story is crucial for bond investors because it implies that the market will not be able to find shelter in Treasuries this year as long term yields rise. Since the '70, US Treasuries' provided negative annual returns only four years (see Figure below). Although long-term yields rose since August, they are still at a historic low level providing a tiny buffer to a fall in Treasuries' prices and making them more vulnerable to just a few basis points movement in yield.

Source: Bloomberg.

The reflation story, however, isn't stopping the primary market from issuing new bonds. Today Mexico is offering 50-year dollar bonds, and three Asian companies are issuing USD green notes. After having issued a record $3.4 trillion in corporate bonds last year, borrowers look to continue to do so at the beginning of this year to secure cheap debt before yields rise.

In Europe, the focus will continue to be on a rise of Covid-19 cases and the direct consequences of a Brexit deal.

This morning we are seeing European sovereign yields falling with the Bund benefitting the most. It is becoming clear that although the vaccination program has started, it will take months if not, even a year to get the population immunized. It suggests that an extension of existing lockdown measures is very likely.

The auction of 10-year Spanish Obligaciones this Thursday will be important to assess the market appetite for peripheral assets. Ten-year Spanish government bond yields dipped below zero in mid-December. However, they closed in positive territory by year-end amid low liquidity and news concerning a new Covid virus strain. Suppose Europe sees an extension of lockdown measures. In that case, 10-year Obligaciones yields are likely to fall back below zero as the market believes that the ECB will endlessly print money until a stable path to recovery has ensued.

This morning, despite the Brexit deal, ten-year Gilt yields trade below 0.20%, pointing to investors still thinking that the Bank of England might cut interest rates below zero. The BOE's governor Andrew Bailey's speech this Wednesday might offer insight into whether negative rates are on the agenda for the next monetary policy meeting on the 4th of February, possibly giving another push to gilts.

Economic Calendar:

Monday, January the 4th

  • China: Caixin Manufacturing PMI
  • Spain: Markit Manufacturing PMI
  • Italy: Markit Manufacturing PMI
  • France: Markit Manufacturing PMI
  • Eurozone: Markit Manufacturing PMI, ECB’s Lane Speech
  • United Kingdom: Markit Manufacturing PMI, Consumer Credit, M4 Money Supply
  • United States: Markit Manufacturing PMI, 3-Month Bill Auction, 6-Month Bill Auction, CFTC Gold, Oil and S&P 5000 Net Position, Fed’s Evans Speech, Fed’s Bostic Speech, Fed’s Mester Speech

Tuesday, January the 5th

  • Germany: Retail Sales, Unemployment Rate
  • Switzerland: Consumer Price Index
  • Eurozone: Private Loans, M3 Money Supply
  •  United States: ISM Manufacturing PMI, Fed’s Williams Speech, Fed’s Mester Speech, Fed’s Evans Speech
  •  Australia: Commonwealth Bank Services PMI

Wednesday, January 6th

  • China: Caixin Services PMI
  • Japan: Consumer Confidence Index, 10-year Bond Auction
  • France: Consumer Confidence, Consumer Price Index
  • Spain: Markit Services PMI
  • Italy: Markit Services PMI
  • France: Markit Services PMI
  • Eurozone: Markit Services PMI, Producer Price Index
  • United Kingdom: Markit Services PMI, BOE’s Bailey Speech
  • Germany: Consumer Price Index, Harmonized Index of Consumer Prices
  • United States: ADP Employment Change, USD Markit Services PMI, Factory Orders, FOMC Minutes

Thursday, January the 7th

  • Australia: Trade Balance
  • Germany: Factory Orders
  • Switzerland: Real Estate Sales, Retail Sales, Consumer Confidence, Consumer Price Index, Industrial Confidence, Business Climate, Economic Sentiment Indicator
  • Eurozone: Economic Bulletin
  • Spain: 10-year Obligaciones Auction, 3-year Bond Auction, 5-year Bond
  • Italy: Consumer Price Index
  • United States: Trade Balance, Jobless Claims, ISM Services PMI, Fed’s Evans Speech, Fed’s Harker Speech, Fed’s Bullard Speech
  • Canada: Ivey Purchasing Managers Index
  • Japan: Overall Household spending, JP Foreign Reserves

Friday, January the 8th

  • Japan: Leading Economic Index
  • Switzerland: Underemployment Rate
  • Germany: Trade Balance, Industrial Production
  • Eurozone: Unemployment Rate
  • United States: Nonfarm Payrolls, Average Hourly Earnings, U6 underemployment Rate, Unemployment Rate, Fed’s Clarida Speech
  • Canada: Unemployment Rate, Average Hourly Wages, Net Change in Employment
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