Fixed income market: the week ahead

While the US economy struggles to recover jobs, commodity prices continue to surge, with the Bloomberg Commodity Index hitting a new high level in years almost every day. Last week, breakeven rates rose to new high levels, with the 10-year Breakeven breaking above 2.5% for the first time since 2012 while the 5-year Breakeven rate rose to 2.70%, the highest since 2008.

The market starts to accept the core message of the Average Inflation Targeting (AIT) framework: despite inflationary pressures continue to strengthen, the Fed will remain impassively dovish. Within this context, bond vigilante might soon start to dump US Treasuries as the risk of a Fed’s monetary policy mistake is rising together with inflation expectations.

Therefore we believe it is necessary to watch out for catalysts that may renew a selloff in US Treasuries. One of them could come as soon as this Wednesday if monthly CPI data comes stronger than forecasted. The market is expecting a 3.6% YoY rise of CPI, the highest since 2011. However, the monthly CPI reading will be more critical because while yearly inflation following the pandemic will be transitory, the monthly may not be.

The 3-, 10- and 30-year Treasury auctions between Tuesday and Thursday will also be important. Our attention is focused on bidding metrics and foreign demand in particular, which is lagging since the beginning of the year.

Are European sovereign yields in check?

In Europe, the focus continues to grow around June’s ECB monetary policy meeting. Today, the central bank's Chief Economist Philip Lane said that the PEPP program could be adjusted in June. He hints at the fact that it may be extended because the economy will most likely require monetary support. Also critical is the recent comment made by the governor of Finland's central bank, Olli Rehn, who said that the ECB should adopt the Fed's AIG framework. Both comments highlight the inclination of the ECB members to provide the central bank with more flexibility to continue purchasing European bonds amid the economic recovery. However, we believe that increased dovishness will not keep in check European sovereign yields because EU government bonds remain tightly correlated to US Treasuries. Therefore, until the german election, European yields will remain vulnerable to changes in US yields. Once US Treasury yields resume rising, we might see a rotation from EU Sovereign to the US safe-haven materializing. Yet, the German election will ultimately push yields higher, provoking Bund yields to turn positive. In the short-term, Bund yields could break below the lower uptrend line of the ascending wedge they have been trading in since March and find new support at -0.40%. However, if they break above -0.15%, they could rise fast to 0%.

Gilts remain stuck at 0.80%, but not for long

UK Gilts are stuck at 0.80% since February. The Scottish elections have failed to give direction. Still, we believe that yields are poised to go higher as the economic backdrop continues to strengthen. On Wednesday, the GDP results will be in focus, and a high read may help 10-year Gilts to break above their resistance line at 0.85% to resume their rise at 1%. While we believe that it is inevitable for Gilt yields to continue to rise, we are still convinced that the BOE will watch at them closely. With the most hawkish member, Haldane, leaving in June, any rise in yields above 1% might increase worries regarding the corporate sector, which is not weakened by the Covid-19 pandemic, but by  Brexit, too. Tomorrow HM Treasury will issue 2061 Gilts. We expect the issuance to be well received because real money is still in desperate need of yield. They recently provided wide support for the recent 30-year issuance, which priced around 1.31%.

Economic Calendar

Monday, May the 10^th

• Australia: National Australia Bank’s Business Confidence, Retail Sales
• China: FDI – Foreign Direct Investment, M2 Money Supply
• Eurozone: Sentix Investor confidence
• Great Britain: BRC Like-For-Like Retail Sales

Tuesday, May the 11^th

• Japan: Overall Household Spending, 10-year Bond auction
• Australia: HIA New Home Sales
• China: Consumer Price Index
• Italy: Industrial Output
• Eurozone: ZEW Survey – Economic Sentiment
• Germany: ZEW Survey – Economic Sentiment and Current Situation
• United States: Fed’s William speech, 3-year Note Auction
• Bank of England: Governor Bailey speech, UK sells 2061 Bonds

Wednesday, May the 12^th

• Australia: Westpac Consumer Confidence
• Japan: Leading Economic Index
• United Kingdom: Trade Balance, Industrial Production, Gross Domestic Product, Manufacturing Production, NIESR GDP Estimate
• Germany: Consumer Price Index
• France: Consumer Price Index
• Eurozone: Industrial Production
• United States: Consumer Price Index, 10-year Note Auction, Monthly Budget Statement

Thursday, May the 13^th

• Japan: Current Account, Trade Balance, Foreign Bond Investment
• Australia: Consumer Inflation Expectations
• United Kingdom: BOE’s Cunliffe speech
• Italy: 3- and 7-year Bond Auction
• United States: Producer Price Index, Initial Jobless Claims, 30-year Bond Auction

Friday, Maty the 14^th

• New Zealand: Business NZ PMI
• Spain: HICP, Consumer Price Index
• Germany: 10-year Bond Auction
• Eurozone: ECB Monetary Policy Meeting Accounts
• United States: Retail Sales, Michigan Consumer Sentiment Index

Saturday, May the 15^th

• Eurozone: Gross Domestic Product