Quarterly Outlook
Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?
John J. Hardy
Global Head of Macro Strategy
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Fixed income market: the week ahead
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Any rally in US Treasuries will be short-lived because the bond market remains sensitive about inflation expectations. This week's CPI numbers, Beige Book and retail sales data might be the catalyst for a deeper selloff. We will look closely at this week 3-, 10- and 30-year bonds' bidding metrics to understand whether foreign investor demand increases. Yet, we believe that foreign investors' support will arrive as 10-year yields hit 2%, leaving US Treasuries vulnerable until then. In Europe, tomorrow's issuance of Italian government bonds will be vital in setting the tone for the periphery. We still believe that there is room for the country to issue bonds with maturity beyond 50-years despite news of increased borrowing needs.
The main takeaway from last week is that US Treasuries remain sensitive to inflation scare. Thus as we head towards recovery and inflation accelerates, the only way for yields is to go higher.
Bearish sentiment in US treasuries ended last week's bond rally amid strong Producer Price Index (PPI) data from China and the United States. Factory inflation in China, the world's biggest exporter, jumped to 4.4% YoY in March to a 2018 high. US PPI also exceeded expectation rising 1% in March, up 4.2% YoY. The quick rise of bond yields amid the release of these data suggests that investors remain suspicious of the Federal Reserve's view that inflation will be transitory and that early tightening cannot be ruled out.
It is essential to highlight that whenever the Federal Reserve talks about inflation, it says it will be transitory. It is the only reason why according to the new Average Inflation Targeting (AIT) framework, the central bank will not intervene amid a spike of CPI index. However, the bond market doesn’t care whether inflation will be temporary or not; what the bond market cares about is inflation expectations, which are currently trading at the highest level in eight years. Therefore, any surprise in inflationary pressures will translate into an acceleration of inflation expectations, driving Treasury yields higher. It is the reason why we remain cautious of US Treasuries, and we expect the consolidation we have recently seen to be short-lived.
CPI numbers tomorrow, the Beige Book on Wednesday and Retail Sales data on Thursday can be catalysts for a deeper selloff in the US safe-havens. Tomorrow the US Treasury will be issuing 3- and 10-year Bonds, while on Wednesday, it will issue 30-year bonds. We will be watching these auctions' bidding metrics closely as we remain concerned about a lack of foreign investors’ demand. We believe that 1.75% remain a critical but weak level in 10-year US Treasuries and that once it is broken, 10-year yields will rise fast to 2%. At this level, we will see a considerable increase in foreign investors demand that will keep yields trading around this level for quite some time.
In Europe, market conditions are becoming worrying for the European Central Bank, which has vowed to keep government bond yields stable. It's clear that the correlation between German Bunds and US Treasuries is strong, and it will hardly be kept close to zero by increased purchases under the Pandemic Emergency Purchase Programme (PEPP). The biggest problem the central bank is facing is the scarcity of Bunds, which explains why the ECB is careful to boost purchases under the PEPP program. According to the Central Bank's capital allocation key’s rules, roughly 25% of the QE purchases have to be in German sovereign debt. However, the market is running out of Bunds, and Germany is not willing to increase its debt-to-GDP ratio. Therefore, in case of a localized selloff, the ECB selloff might not have adequate tools to contain the crisis. In a recent analysis, we see conditions building up for another European sovereign crisis as rotation from the European sovereigns to the US safe-havens becomes appealing.
It might be something that the former president of the ECB, Mario Draghi, understands well, and that's why he decided to issue more debt while markets are accommodative. Italy has already spent more than EUR 130 billion to support the economy from the COVID-19 pandemic, and now it will increase the bill by EUR 40 billion.
We believe that the market will binge on Italian debt without problems for the simple reason that there is no other alternative in the euro area. Greek sovereigns offer a higher yield but are rated junk and highly illiquid, posing a considerable threat to bond investors. On the other hand, liquidity in Italian sovereigns is good, and the sentiment is remarkably positive. While European sovereigns have recorded an average loss of 2% since the beginning of the year, BTPS recorded a loss of only 1% as Draghi entered Italian politics. Yet, the most important quality of Italian debt is coupon income amid a yield-starved bond market. Last week’s issuance of a new 50-year benchmark has seen order books over EUR 64 billion. Such extraordinary demand can only be explained by the fact that the bonds were priced with a coupon of 2.15%, which is one of the highest in the euro area. For real money, long-term investors such as insurances and pension funds make more sense to be invested in a 50-year maturity in Italy at 2.15% (IT0005441883) than France at 0.5% (FR0014001NN8). The French 50-year benchmark issued in January is already down 15% as interest rates changes continue to erode the bonds’ value amid extremely high duration.
Tomorrow Italy is to issue 3-, 5- and 15-year bonds. We believe that if demand is strong, Italy might consider issuing bonds beyond 50-year maturities as the cost of funding continues to be extraordinarily low, and the government will be able to lock in a conveniently low yield.
Economic Calendar
Monday, the 12th of April
- China: Foreign Direct Investment, M2 Money Supply
- Eurozone: Retail Sales
- Canada: Bank of Canada Business Outlook Survey
- United States: 3- and 10-year Note Auction, Fed’s Rosengren speech, Monthly Budget Statement
Tuesday, the 13th of April
- New Zealand: NZIER Business Confidence
- Australia: National Australia Bank’s Business Confidence
- China: Trade Balance
- United Kingdom: Trade Balance, Industrial Production, Manufacturing Production, Gross Domestic Product, NIESR GDP Estimate, 50-year Bonds
- Eurozone: ZEW survey – Economic Sentiment
- Germany: ZEW survey – Economic Sentiment and Current Situation, 10-year Bond Auction
- Netherlands: 15-year Bond Auction
- Italy: 15-year Bond Auction
- United States: Consumer Price Index, 30-year Bond Auction
Wednesday, the 14th of April
- Australia: Westpac Consumer Confidence
- New Zealand: RBNX Rate Statement and Interest Rate Decision
- United Kingdom: 30-year Inflation Linkers
- Eurozone: Industrial Production
- Germany: 30-year Bond Auction
- United States: Fed’s Beige Book, Fed’s William Speech
Thursday, the 15th of April
- Australia: Consumer Inflation Expectations, Fulltime Employment, Unemployment rate
- Germany: Harmonized Index of Consumer Prices
- France: Consumer Price Index
- Italy: Consumer Price Index
- United States: Retail Sales ex-Auto, Philadelphia Fed manufacturing Survey, Retail Sales Control Group, Initial Jobless Claims, Retail Sales
Friday, the 16th of April
- Eurozone: Eurogroup Meeting, Trade Balance, Consumer Price Index
- China: NBS Press Conference, Industrial Production, Gross Domestic Product, Retail Sales
- United States: Building Permits, Housing Starts
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