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 it's all about job data and how any surprise may push US Treasury yields higher. Strong inflationary pressures combined with a fast jobs recovery may lead the Federal Reserve to taper earlier than expected. Nevertheless, if the central bank doesn't taper, the market might run into a monetary policy mistake. It's crucial to hedge against these risks by seeking coupon income and decreasing duration sensibly. On Thursday, the Bank of England is likely to upgrade its economic outlook. The Bank's Monetary Policy Committee (MPC) might discuss the tapering of bond purchases under the quantitative easing program and interest rate hikes. If 10-year Gilts break resistance at 0.85%, they may rise fast to find new resistance at 1%. In Europe, Bund yields have broken above -0.20% this morning. They will find the next resistance at -0.15%, and if they break this resistance too, they will be headed to 0%. European sovereign yields will remain vulnerable to US yield changes until the German elections.
Job data are a focus this week, and they could add steam to the reflation trade.
Although Jerome Powell assured that economic conditions are still far from optimal last week, the market is starting to price a sudden U-turn in monetary policies. Inflationary data are strengthening by the day. If jobs are recovering faster than expected, the Federal Reserve might need to tighten financial conditions earlier than expected. This Friday's nonfarm payrolls are expected to show that the US economy created 978,000, the most significant increase since last August. Unemployment is also expected to fall to 5.7% from 6% prior. Any surprise in these data may indicate a faster than expected economic rebound in the United States, pushing forward the central bank’s tapering agenda.
Ahead of Friday's nonfarm payroll, we will be watching ISM manufacturing and services reports coming out today and Wednesday. Also, the initial jobless claims on Thursday will be critical. Claims have dropped to 553k recently but remain well above healthy market condition, which is believed to be around 250k.
Suppose the Fed won’t start tightening the economy amid strong economic and inflationary data, therefore the risk of a policy mistake increases. So far, there are no elements to suggest that up ticking inflation will be temporary. Therefore, if the Federal Reserve's intervention comes too late, inflation might get out of control, and interest rates will need to rise exponentially.
Today Powell will speak at a virtual event hosted by the National Community Reinvestment Coalition. We don't expect him to offer fresh insight into the economic recovery. However, it will be necessary to listen to his speech to understand whether there is any relaxation surrounding tapering considerations. Across the Atlantic, the Bank of England will upgrade the growth outlook as the pace of the recovery is accelerating amid a fast vaccination program and easing of lockdown measures. Bond investors will need to watch out for clues concerning possible interest rate hikes and tapering of the £895 billion quantitative easing program.
Gilt yields have consolidated between 0.65% and 0.85% after a fast rise in February. If they break above 0.85%, they may rise fast to find resistance at 1%.
As government bond yields are rising across the world, Bunds are not left untouched. This morning 10-year Bund yields broke above their resistance line at -0.20%. As we have outlined in an earlier analysis, despite increased purchases under the PEPP program, the ECB has not been able to break the correlation between European sovereigns and US Treasuries. Therefore, we expect government bonds in the EU to remain vulnerable to changes in US yields until fall.
The German election will bring a much-needed change in the bond market as ongoing electoral campaigns open up to better European integration and greater fiscal spending. It means that Bund yields will not be negative for long and that cost of funding across the euro area would level out.
Yields will find strong resistance at -0.15%. If they break above this level, there is the possibility we might see them rising fast to 0%.
Economic Calendar
Monday, May the 3rd
- Australia: TD Securities Inflation, ANZ Job Advertisement, RBA Commodity Index SDR
- Germany: Retail Sales, Markit Manufacturing PMI
- Spain: Markit Manufacturing PMI
- Switzerland: SVME – Purchasing Managers’ Index
- Italy: Markit Manufacturing PMI
- France: Markit Manufacturing PMI
- Eurozone: Markit Manufacturing PMI, Sentix Investor Confidence
- Canada: Markit Manufacturing PMI
- United States: Markit Manufacturing PMI, ISM Manufacturing Employment Index, ISM Manufacturing PMI, ISM Manufacturing Prices Paid, 3- and 6-month Bill Auction, Fed’s Chair Powell speech
Tuesday, May the 4th
- Australia: Trade Balance, RBA Interest rate Decision and Rate Statement
- United Kingdom: Markit Manufacturing PMI, Consumer Credit, M4 Money Supply, Mortgage Approval
- Spain: 6- and 12-month Letras auction
- United States: Goods and Service Trade Balance, Factory Orders
- Canada: International Merchandise Trade
Wednesday, May the 5th
- New Zealand: RBNZ Financial Stability Report, Participation Rate, Labour Cost Index, Employment Change Unemployment Rate
- Australia: Commonwealth Bank Services PMI, Building Permits
- Switzerland: Consumer Price Index
- Spain: Markit Services PMI
- Italy: Markit Services PMI
- France: Markit Services PMI
- Germany: Markit Services PMI, Markit PMI Composite
- Eurozone: Markit Services PMI, Markit PMI Composite
- United Kingdom: 10-year Bond Auction
- United States: ADP Employment Change, Markit Services PMI, Markit PMI Composite, ISM Services PMI, ISM Services Employment Index, ISM Services Prices Paid
Thursday, May the 6th
- Japan: BOJ Monetary Policy Meeting Minutes
- China: Caixin Services PMI
- Germany: Factory Orders
- Eurozone: Economic Bulletin, Retail Sales
- Spain: 3-, 5-, 10-year Bonds Auction
- France: 10-year Bond Auction
- Australia: RBA’s Debelle speech
- United Kingdom: BOE Interest Rate Decision, Bank of England Monetary Policy Report, BOE MPC Vote Unchanged, BOE Asset Purchase Facility, Monetary Policy Summary, Bank of England Minutes, BOE’s Governor Bailey speech
- United States: Nonfarm Productivity, Initial Jobless Claims, Unit Labor Costs, Fed’s William Speech
Friday, May the 7th
- Australia: RBA Monetary Policy Statement
- China: Trade Balance, Foreign Exchange Reserves
- New Zealand: RBNZ Inflation Expectations
- Switzerland: Unemployment Rate
- Germany: Trade Balance, Industrial Production
- France: Trade Balance, Industrial Production, Nonfarm Payrolls
- United States: Nonfarm Payrolls, Average Hourly Earnings, Labor Force Participation Rate, U6 Underemployment Rate, Unemployment Rate
- Canada: Unemployment Rate, Participation Rate, Average Hourly Wages, Ivey Purchasing Managers Index
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