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: The escalation of geopolitical tensions in Ukraine will be a focus this week as it could bear-flatten the US yield curve further. The belly of the curve is already partially inverted as markets prepare for a more aggressive Federal Reserve. However, investors should worry about the 2s5s and 2s10s spreads which are flattening fast and will signal an imminent recession upon inversion. In Europe, a potential war in Ukraine and ECB's monetary policies will be in focus as the BTPS-Bund spread continues to widen. In the UK, jobs, and inflation data could trigger more aggressive interest rate hikes expectations, putting upward pressure on yields.
US Treasuries: the bear flattening will continue.
War. That's the focus of the week as markets were left in disarray on Friday after the White House warned that a Russian attack on Ukraine could happen any day. The Nasdaq fell by -2.78%, while the S&P dropped by -1.9%. US Treasury yields dropped across maturities sending the critical message that investors still see the US safe-haven as a refuge in case of war. That adds a key piece to the puzzle when considering future yield curve developments as it implies that the long part of the yield curve will remain compressed. Still, short-term yields will continue to adjust to the Fed's aggressive stance against inflation growth.
Indeed, a war might add to inflation concerns as Russia is a significant producer of oil, natural gas, and palladium. If the west imposed sanctions, energy price pressures would exacerbate, forcing the Federal Reserve to tighten the economy further. With the 2s10 and 5s30s spreads around 40bps, it isn’t bizarre to envision an inversion of the yield curve, which could further strangle growth.
The yield curve’s belly is already signaling an inversion. The 7s10s year spread inverted last week, while the 5s10s spread trades in the single digits and could invert any day. An inversion in the belly of the curve doesn't indicate an imminent recession; it simply suggests that the Fed is behind the curve and that the market is preparing for a severe rate hiking cycle. Things will be different when the 2s10s spread approaches the single-digit, indicating that aggressive hiking and possibly war are weighing on growth. Nevertheless, we are far from that as the economy is still forecasted to expand above trend this year.
Investors' focus has turned on the March FOMC meeting and whether the Fed will deliver a 50bps rate hike in light of last week's higher-than-expected CPI reading. If the central bank disappoints expectations, that could be a sign the Fed is not serious enough in fighting inflation. Hence, markets will consider even a more aggressive tightening plan in the future, increasing the chances of a tantrum. That's why we believe that the chances of a 50bps rate hike in March are becoming increasingly more likely.
Hence, this week’s Fed's official speeches will be in the spotlight, primarily because Fed's voting members will deliver the majority of them. Inflation data will also be in focus with the PPI numbers coming out tomorrow and retail sales on Wednesday. In terms of US Treasury auctions, there will be a 20-year bond sale on Wednesday and a 30-year TIPS sale on Thursday.
European sovereigns: war and ECB policies in focus.
A possible war in Ukraine weighs on European sovereigns as well. Today, we see German Bunds leading gains as investors fly to safety. It gives respite to the ECB, which saw yields skyrocketing as the market runs ahead to price more aggressive monetary policies. Yet, one of the leading indicators of ECB monetary policies continues to flag troubles ahead. Despite yields dropping in the euro area, the BTPS-Bund spread widens. Although it is true that the Italian debt-to-GDP ratio is not on a steep uptrend, and that yields on Italian BTPS will need to rise much higher for the interest burden to become unsustainable, the BTPS-Bund spread gives us a good idea of how tolerant the ECB can be in light of financing conditions tightening faster in the south of Europe versus the north.
The prospect of a war in Ukraine could provoke markets forecasting a faster hiking cycle even in Europe, contributing to increasing rates volatility in the euro area. That's why today's Olaf Scholz meeting in Kyiv and tomorrow's in Moscow will be in the spotlight.
While Lagarde today will most likely join the chorus of ECB’s speakers saying that the central bank might hold hiking rates, we believe it is unlikely that the market will stop advancing rate hikes as tightening expectations continue to increase worldwide.
UK Gilts have not finished with their selloff.
It is going to be a crucial week for UK data. Jobs figures will be released tomorrow, followed by inflation data the day after and retail sales numbers on Friday.
Investors are going to look at these data and consider what the response of the BOE will be. Although four members out of nine voted for a 50bpasis points increase of 25bps, the central bank was not seen hawkish enough during last month’s monetary policy press conference. Suppose this week's data show a tight labor market and rising inflation. In that case, it could be enough for markets to advance interest rate hikes to catch up with the Fed across the Atlantic or even overtake it. It implies we might see the Gilt yield curve flattening further and the 2s10s spread even inverting.
Economic Calendar
Monday, February the 14th
- Eurozone: ECB’s President Lagarde speech
- United States 3-month and 6-mont Bill Auction
Tuesday, February the 15th
- Japan: Gross Domestic Product (Q4)
- United Kingdom: Average Earnings Excluding Bonus (Dec), Claimant Count Change (Jan), ILO Unemployment Rate (Dec), 10-year Bond Auction
- China: FDI – Foreign Direct Investment (Jan)
- Spain: Harmonized Index of Consumer Prices (Jan)
- Eurozone: Gross Domestic Product (Q4), ZEW Survey – Economic Sentiment (Feb)
- Germany: ZEW Survey – Current Situation and Economic Sentiment (Feb)
- United States: Producer Price Index (Jan)
Wednesday, February the 16th
- China: Consumer Price Index (Jan)
- United Kingdom: Consumer Price Index (Jan), PPI Core Output (Jan), Retail Price Index (Jan)
- Eurozone: Non-monetary Policy ECB Meeting, Industrial Production (Dec)
- Germany: 10-year Bond Auction
- United States: Retail Sales (Jan), Export and Import Price Index (Jan), 20-year Bond Auction, FOMC Minutes
- Canada: BoC Consumer Price Index (Jan)
Thursday, February the 17th
- Japan: Merchandise Trade Balance (Jan), Export and Imports (Jan), Foreign Bond Investment
- Australia: Employment Change (Jan), Fulltime Employment (Jan), Unemployment Rate
- Eurozone: ECB’s Schnabel speech, Economic Bulletin, ECB’s Lane Speech
- Switzerland: Trade Balance (Dec)
- Italy: Trade Balance
- United States: Building Permits (Jan), Housing Starts (Jan), Initial Jobless Claims, Philadelphia Fed Manufacturing Survey (Feb)
Friday, February the 18th
- Japan: National Consumer Price Index (Jan)
- France: ILO Unemployment (Q4), Consumer Price Index (Jan)
- United Kingdom: Retail Sales (Jan)
- Eurozone: ECB’s Elderson speech, Current Account (Nov), Construction Output (Dec), ECB’s Panetta speech, Consumer Confidence (Feb) Prel
- Canada: Retail Sales (Dec)
- United States: Fed Monetary Policy Report
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