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: Geopolitical tensions and central banks' monetary policies remain at the forefront of market concerns. Fears of a possible war in Ukraine will compress long-term yields while lifting the short part of the yield curve as the market considers higher energy prices. Strong Eurozone PMI readings and an elevated US PCE Index might also contribute to advance rate hike expectations. Uncertainty in bond markets will undoubtedly remain elevated, contributing to volatility and a steady bear-flattening of the US and UK yield curve. In Europe, the focus will be on ECB official speeches and the possibility of early stimulus termination.
Uncertainty in bond markets will remain high.
Another week starts with the market focusing on a possible escalation of tensions in Ukraine. The situation is unclear, with reports showing that Russia is ready to invade Ukraine any moment on one side and Emmanuel Macron brokering a summit between Vladimir Putin and Joe Biden on the other. What is certain is that volatility is likely to maintain elevated until Russian troops pull back from the Ukrainian border. Until then, we can expect the equity market to remain vulnerable and US Treasuries and Gold to serve as safe-haven.
Yet, geopolitical tensions are not alone in moving the US Treasury market. Expectations of a more aggressive Federal Reserve continue to adjust, causing the front part of the yield curve to advance or pare back interest rate hikes. While at the beginning of last week, markets were pricing a 50bps rate hike next month, by Friday, expectations dropped to 25bps. Fed official speeches contribute to uncertainty in the rates market, as they do not give explicit direction regarding the central bank's intentions. As money market guru Zoltan Pozsar highlighted in recent research, uncertainty could benefit the Federal Reserve's purpose to tighten the economy more efficiently to fight inflationary pressures.
He explains that a way to do so is to spark a market crash, which causes much labor tightness.
Even if the Fed does not want to cause a selloff voluntarily, it might be nearly impossible for it to avoid a tantrum. On the one hand, if it does not do enough to curb inflation, it could spark an inflation tantrum. On the other, if it is too aggressive, a taper tantrum might ensue.
This week, investors will need to focus on the Personal Consumption Expenditure Index released on Friday, which is expected to come out at 6%. An overshoot might revive more aggressive interest rate hikes expectations. Before Friday, the focus will be on the 2-year, 5-year. 7-year US Treasury auction starting tomorrow and on Federal Reserve speakers.
Investors will focus on central banks' intentions in Europe and the UK
In Europe, the focus is on the PMI February data released this morning, which shows the recovery is underway after the winter lockdowns. It might encourage central banks to unwind pandemic stimulus faster than expected. Therefore, the focus will be on central bank officials and their speeches this week. In the UK, Bailey will speak in front of the Parliament's Treasury Committee to answer questions about the economy and inflation. In the eurozone, de Cos, Guindos, Schnabel, and Panetta speak throughout the week.
Although it's inevitable for the ECB to assume a less accommodative stance with the BOE and Federal Reserve hiking interest rate aggressively, we believe that the BTPS-Bund spread is a good indicator of how far the ECB can go. So far, the BTP-Bund spread remains below 200bps, leaving the central bank without preoccupations. However, as it widens above this level, we expect ECB officials to become more cautious.
Geopolitical tensions in Ukraine will also be a focus in the eurozone. Rising tensions could see energy prices soaring, contributing to even more aggressive monetary policies.
Economic calendar
Monday, February the 21st
- United Kingdom: Rightmove House Price Index (Feb), Markit Manufacturing PMI, Services PMI
- Japan: Jibun Bank Manufacturing PMI (Feb)
- China: PBoC Interest Rate Decision, House Price Index (Jan)
- Germany: Producer Price Index (Jan), Markit Manufacturing PMI, Services PMI and PMI Composite (Feb) Prel, German Buba Monthly Report
- France: Markit Manufacturing PMI, Services PMI and PMI Composite (Feb) Prel
- Eurozone: Markit Manufacturing PMI, Services PMI and PMI Composite (Feb) Prel
- United States: President' Day
Tuesday, February the 22nd
- New Zealand: Credit Card Spending (Jan)
- Italy: Consumer Price Index (Jan)
- Germany: IFO – Business Climate (Feb), IFO – Current Assessment (Feb), IFO – Expectations (Feb)
- United Kingdom: BOE’s Ramsden speech
- United States: Redbook Index, Housing Price Index (Dec), S&P/Case-Shiller Home Price Indices (Dec), Markit Manufacturing PMI, Services PMI and PMI Composite (Feb) Prel, Consumer Confidence (Feb), Markit Manufacturing PMI, Services PMI and PMI Composite (Feb) Prel, 3-month Bill Auction, 52-Week Bill Auction, 6-month Bill Auction, 2-year Note Auction
Wednesday, February the 23rd
- Australia: Wage Price Index (Q4)
- New Zealand: RBNZ Interest Rate Decision and Press Conference
- Germany: Gfk Consumer Confidence Survey (Mar)
- France: Business Climate in Manufacturing (Feb)
- Switzerland: ZEW Survey – Expectations (Feb)
- Eurozone: HICP (Jan)
- United Kingdom: BOE Monetary Policy Report Hearings
- United States: MBA Mortgage Applications, 5-year Note Auction
Thursday, February the 24th
- Australia: Private Capital Expenditure (Q4)
- Switzerland: Employment Level (Q4)
- France: Consumer Confidence (Feb)
- Italy: Industrial Sales (Dec)
- United States: Chicago Fed National Activity Index (Jan), Core Personal Consumption Expenditures (Q4) Prel, New Home Sales Change (Jan), 7-year Note Auction
Friday, February the 25th
- New Zealand: Retail Sales (Q4)
- Japan: Tokyo Consumer Price Index (Feb), Tokyo CPI ex Food, Energy (Feb), Foreign Bond Investment, Foreign Investment in Japan Stocks
- Germany: Gross Domestic Product (Q4), Import Price Index (Q4)
- France: Consumer Price Index (Feb) Prel, Consumer Spending (Jan), Gross Domestic Product (Q4)
- Italy: Business Confidence (Feb), Consumer Confidence (Feb)
- Eurozone: M3 Money Supply (Jan), Private Loans (Jan), Business Climate (Feb), Consumer Confidence (Feb)
- United States: Core Personal Consumption Expenditures (Jan), Durable Goods Orders (Jan), Personal Income (Jan), Personal Spending (Jan), Michigan Consumer Sentiment (Feb), Pending Home Sales (Jan).
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