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Fixed income market the week ahead
Summary: We believe that the Federal Reserve will stick to its hiking plan or become even more aggressive as the economy remains strong, but elevated inflation pressures persist. Therefore, there continues to be space for the US yield curve to bear-flatten. Although 2-year yields are currently pricing rate hikes for the whole year, they could continue to soar to 2.5% as the Federal Reserve maintains hawkish. Within this context, long-term yields are unlikely to drop until there are clear signs of stagnation. Things could change during the second half of the year if the probabilities of a contraction rise.
Last week's central banks' monetary policy meetings left the market reassessing inflationary risks and the growth outlook.
Breakeven rates soared substantially, with the 5-year breakeven rate rising to 3.67% on Friday, the highest on record. The US yield curve continued to flatten with the 3s10s spread inverting for the first time since 2007. The move indicates that bond investors are increasingly worried that the Federal Reserve's aggressive monetary policies will contribute to a noticeable slowdown in growth.
Yet, the Fed completely dismissed these worries. Indeed, in its updated economic projections, growth remains above 2% until 2024. The unemployment rate will maintain somewhat stable, increasing in 2024 from 3.5% to 3.6% only.
Breakeven rates soared substantially, with the 5-year breakeven rate rising to 3.67% on Friday, the highest on record. The US yield curve continued to flatten with the 3s10s spread inverting for the first time since 2007. The move indicates that bond investors are increasingly worried that the Federal Reserve's aggressive monetary policies will contribute to a noticeable slowdown in growth.
Yet, the Fed completely dismissed these worries. Indeed, in its updated economic projections, growth remains above 2% until 2024. The unemployment rate will maintain somewhat stable, increasing in 2024 from 3.5% to 3.6% only.
Although it's challenging to forecast the economic outlook due to the evolving situation in Ukraine, it’s fair to assume that the Fed will stick to its hiking plan to fight inflation. Suppose the central bank is concerned about a slowdown in growth. In that case, it will look to front-load interest rate hikes this year as the economy remains strong and the choice to fight inflation remains popular. Therefore, it’s safe to expect the yield curve to continue to bear-flatten.
Since last week, two-year US Treasury yields have been testing strong resistance at 2%, a level previously seen in May 2019, when the Fed fund rate was 2.5%. The Fed is looking to bring the benchmark rate at 2% by the end of the year and 2.75% in 2023. Suppose markets deem this hiking path to be realistic. In that case, there is definitively room for 2-year US Treasury yields to begin to price rate hikes for 2023 throughout the year. Yet, rate hikes for this year have already largely been priced in the front part of the yield curve. Therefore, two scenarios are possible: either growth remains sustained throughout the year, giving the green light to the Fed to hike rates as planned, or growth will get seriously hit in the second half of the year, forcing the market to reconsider rate hikes for 2023. We would probably see 2-year yields moving towards 2.5% in the first scenario. In the second scenario, the front part of the yield curve would remain around the values we see today.
We believe that there is a bigger chance of seeing 2-year yields breaking above 2% in the short term and remaining sustained above this level until summer as the central bank's language has become hawkish. However, as the macroeconomic outlook becomes clearer, there are chances that the market begins fearing a recession. In that case, 2-year yields would remain around the levels we are currently seeing.
Similarly, we don't believe that long-term yields will plummet unless there are clear signs of stagnation, which might not surface until the year's second half.
This week's focus is on the Fed officials' speeches, starting today with Powell commenting on the economic outlook at the National Association for Business Economics annual conference. Powell will also speak on Wednesday in front of the Bank for International Settlements. We'll also hear from Williams, Daly, Mester, Kashkari, Waller, and Evans
throughout the week.
The 2-year and 20-year US Treasury bond auctions on Wednesday will also be in focus. It will be critical to see how investors position in the short-term versus the long-term of the yield curve in light of last week's FOMC meeting.
What's going on elsewhere?
In Europe, the focus will be on the PMI data and ECB officials speaking. Lagarde is speaking today and tomorrow.
Although Russia avoided defaulting on its own debt last week, it's a matter of time before we see defaults rising in that part of the world. Sadly, the Ukrainian poultry, grain, and meat producer MHP is the first Ukrainian company to default on its US dollar debt due to the war.
In Venezuela, government and PDVSA bonds have jumped from 6 to 10 cents on the dollar as investors speculate on a US deal.
Economic calendar
Monday, March the 21st
- New Zealand: Trade Balance
- China: PBoC Interest Rate Decision
- Germany: Producer Price Index (Feb), German Buba Monthly Report
- United States: Chicago Fed National Activity Index, 3-Month and 6-Month Bill Auction, Powell speaks at NABE, Bostic speaks
Tuesday, March the 22nd
- New Zealand: Westpac Consumer Survey
- Australia: RBA’s Governor Lowe’s speech
- Eurozone: Current Account (Jan), Construction Output (Jan)
- Canada: Industrial Product Price Index (Feb)
- United States: Redbook Index, Richmond Fed Manufacturing Index, 52-Week Bill Auction, Williams, Daly, and Mester speak
Wednesday, March the 23rd
- United Kingdom: Consumer Price Index (Feb), PPI Core Output (Feb), Producer Price Index – Input (Feb), Retail Price Index (Feb)
- Eurozone: Non-monetary Policy ECB Meeting, Consumer Confidence (Mar) Prel
- United States: New Home Sales (Feb), 20-year Bond Auction, Powell speaks at the BIS Panel, Daly, Bullard speak
Thursday, March the 24th
- Australia: Commonwealth Bank Manufacturing PMI (Mar) prel
- Japan: BoJ Monetary Policy Meeting Minutes
- France: Markit Manufacturing PMI (Mar) prel, Markit PMI Composite (Mar) prel, Markit Services PMI (Mar) prel
- Germany: Markit Manufacturing PMI (Mar) prel, Markit PMI Composite (Mar) prel, Markit Services PMI (Mar) prel
- Eurozone: Economic Buletin, Markit Manufacturing PMI (Mar) prel, Markit PMI Composite (Mar) prel, Markit Services PMI (Mar) prel
- United Kingdom: Markit Manufacturing PMI (Mar) prel, Markit Services PMI (Mar) prel
- United States: Nondefense Capital Goods Orders ex Aircraft (Feb), Initial Jobless Claims, Durable Goods Orders (Feb), Markit Manufacturing PMI (Mar) prel, Markit PMI Composite (Mar) prel, Markit Services PMI (Mar) prel, 4-Week Bill Auction, Bullard, Kashkari, Waller, Evans, and Bostic speak
Friday, March the 25th
- Japan: Tokyo Consumer Price Index (Mar), Foreign Bond Investment, Foreign Investment in Japan Stocks
- Eurozone: EU Leaders Summit, M3 Money Supply (Feb), M3 Money Supply (Feb), Private Loans (Feb)
- United Kingdom: GfK Consumer Confidence (Mar), Retail Sales (Feb), Retail Sales ex-fuel (Feb)
- Spain: Gross Domestic Product (Q4)
- Italy: Business Confidence (Mar), Consumer Confidence (Mar), Trade Balance (Feb)
- Germany: IFO- Business Climate, Current Assessment, and Expectations (Mar)
- United States: Michigan Consumer Sentiment Index (Mar), Pending Home Sales (Feb), Daly, Waller, Williams, and Barkin speak