Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Fixed income market: the week ahead
Althea Spinozzi
Head of Fixed Income Strategy
Summary: This week's market focus will be on central bank's speakers, and their position concerning rising government yields as recovery and inflation expectations grow. BOE's Bailey's speech today and Wednesday could push 10-year Gilt yields to test their resistance level at 0.65%. In Italy, we will see the 30-year BTP-Bund spread tightening to 120bps as Mario Draghi consolidates his position among Italian political parties. In the United States, CPI readings and the 10-year Treasury auction on Wednesday will set sentiment ahead of Powell's speech. We expect the selloff in Treasuries to intensify affecting long term maturities.
This morning, the European sovereign market has opened softer due to Christine Lagarde's hawkish comments that see 2021 as the economic recovery year. The central bank is already envisioning a post-pandemic phase in which monetary and fiscal support will need to be waned down gradually. However, the market is still relying on additional monetary support as restrictions weigh on the bloc’s economic outlook amid a slow start to the vaccination campaign. On Thursday, the European Commission publishes its Economic forecasts. In case they are revised down, we anticipate spread compression among European sovereigns to resume. Indeed, monetary policies will remain the only tool to stimulate the economy as additional fiscal stimulus is unlikely amid the German elections.
While European sovereigns selloff, Italian BTPs remain resilient at Mario Draghi's prospect to form a new government. According to national news, Draghi has broad support among several parties including Matteo Salvini's Northern League, the right-wing party that now leads national polls. Today and tomorrow Draghi will start the second round of talks with parties, and if they go well he might announce his cabinet picks before facing a confidence vote in both houses of parliament. Last week, the 10-year spread between the BTP and the Bund fell below 100bps for the first time in nearly six years. Yet, we believe that 30-year BTPs are set for more significant upside as the 30 years BTP-Bund spread has the potential below 120bps.
In the United Kingdom, Bank of England’s governor Bailey’s speeches today and Wednesday will be on the spotlight ahead of the Gross Domestic Product released on Friday. Gilts continue to sell off days after the BOE's held its monetary policy meeting. This morning 10-year yields have broken above their upper trendline at 0.5%, making 0.65% their new resistance level. Although Gilt yields remain at the lowest level in history, it will be essential to understand whether the BOE is comfortable with their quick rise. If yields continue to rise, they may hamper the spending binge that the governor Baileys anticipates in the second half of the year.
Nevertheless, the hot story in the bond market today is that 30-year US Treasury yields tested the 2% pivotal level as the reflation trade becomes more compelling. Amid the market's excitement over rising Treasury yields to pre-pandemic levels, the 10-year Breakeven rate has silently hit a new record this morning too by rising to the highest level in nearly seven years. Right now 10-year US Treasury yields are lagging behind the breakeven rate by 100bps making a deeper selloff in US Treasuries very likely -unless the Federal Reserve is engaging in yield curve control.
We expect the US yield curve to continue to steepen amid the reflation story, and this week will be key to monitor how comfortable Powell feels about it. Janet Yellen on Sunday pushed for the $1.9 trillion fiscal stimulus package saying that if it passes, the US will see full employment as soon as next year. It will be interesting to know whether the Federal Reserve shares the same view and if tightening will be considered then. The Consumer Price Index will be released on the same day. The Treasury is to issue 10- and 30-year bond on Wednesday and Thursday. There is a risk of seeing a deep selloff in Treasuries if strong CPI readings are combined with bond indigestion in the Treasury auctions. Ten-year yields can sell off fast above 1.2% rising towards 1.5%, while 30-year yields might test their new resistance at 2.1%.
Economic Calendar
Monday, the 8th of February
- Switzerland: Unemployment Rate
- Germany: Industrial Production
- United Kingdom: BOE Governor Andrew Bailey Speaks to Treasury Committee
- Eurozone: Sensex Investor Confidence, Lagarde speaks in the European Parliament
Tuesday, the 9th of February
- United Kingdom: BRC Like-For-Like- Retail Sales,
- New Zealand: RBNZ Inflation Expectations
- China: Trade Balance
- Germany: Trade Balance
- Australia: Westpac Consumer Confidence
Wednesday, the 10th of February
- Australia: HIA New Home Sales
- China: Consumer Price Index
- Germany: Consumer Price Index
- United Kingdom: NIESR GDP Estimate, BOE’s Governor Bailey speech
- United States: Consumer Price Index, to sell $41 billion of 10-year Notes, Powell speaks to the Economic Club of New York
Thursday, the 11th of February
- Australia: Consumer Inflation Expectations
- China: Foreign Direct Investment
- United States: Continuing and Initial Jobless Claims, to sell $27 billion of 30-year bonds
- New Zealand: Business NZ PMI
- Italy: To sell 3- and 7-year Bonds
- Eurozone: European Commission publishes Economic forecasts
Friday, the 12th of February
- United Kingdom: Manufacturing Production, Industrial Production, Gross Domestic Product
- Switzerland: Consumer Price Index
- Eurozone: Industrial Production
- United States: USD Michigan Consumer Sentiment Index
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