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 a surge of Covid-19 cases and inflation. The debt ceiling issue will keep long-term yields in check in the United States while spurring volatility in money markets. Lack of collateral and new lockdown measures are also compressing spreads in the Euro area. Yet, policymakers' engagement to the idea of less accommodative monetary policies on both sides of the Atlantic indicates that yields will not remain rangebound for long. Once the lid is lifted, inflationary pressures will push yields higher. Therefore, it's safe to assume a continuous bear flattening of yield curves.
US Treasuries: volatility in money markets will keep long-term yields in check. Yet, inflation concerns continue to grow, pointing to higher rates once the debt ceiling issue is resolved.
This week, investors will need to focus on the Fed Minutes released on Wednesday, inflation numbers, and the White House's announcement concerning the Federal Reserve Chair nomination.
The Fed’s minutes might unveil details regarding the decision that led to tapering this month and whether FOMC members begin to fret about inflationary pressures. Last week, several Fed’s speakers opened up about accelerating tapering and hiking interest rates in 2022. Among them, Fed Vice Chair Richard Clarida called for a discussion to expedite tapering to enable the central bank to hike interest rates sooner.
At the same time, if Biden nominates Leal Brainard as Fed Chair, it could advance inflation worries. Brainard is known to be more dovish than Powell. In the case of her nomination, the market could anticipate interest rates to remain low for longer, implying stickier inflation, provoking a selloff in bonds.
The Personal Consumption Expenditure Index, one of the inflation data most looked at after the Federal Reserve, will be released on Wednesday. The PCE core deflator index YoY is expected to rise to 4.1%, the highest in more than 31 years. As we mentioned in earlier editions of “Fixed income market: the week ahead”, we expect inflationary pressures to continue to rise and higher rents, housing and wages to make inflation stickier, putting at odds policymakers’ transitory narrative.
Therefore, although the US yield curve has already flattened substantially, we cannot expect anything else than more flattening. The only difference is that once the debt ceiling issue is resolved, long term yields will need to rise together with short term yields, putting at risk weaker credits.
The debt ceiling will be a crucial topic for December. Janet Yellen has said that the US Treasury will run out of cash soon after the 3rd of December if an agreement over the debt ceiling is not found. However, money markets have started to price a default during the second half of December. Indeed, last week's 4-week T-Bills auction was priced with a yield of 0.11%, more than double the Reverse Repurchase facility rate. We expect volatility in money markets to continue to remain elevated until the debt ceiling is lifted or suspended. Until then, the long part of the yield curve will serve as a safe haven causing yields to remain compressed. Yet, once the debt ceiling hurdle has cleared, long-term rates will resume their rise.
European sovereigns: lack of collateral and a surge in Covid-19 cases will keep yields compressed. Yet, something is changing among policymakers.
In Europe, governments are imposing new lockdown measures due to increasing Covid-19 cases, causing yields to drop significantly. Yet, inflationary forces have already been set into motion. Another lockdown might exacerbate inflation further as consumption will switch from services to goods, putting more pressure on prices. Meanwhile, policymakers have started to open to the possibility that upside inflation risk might remain throughout winter. Therefore, near-term hikes expectations are unlikely to reverse despite new lockdown measures.
Yet, lack of collateral in the euro area contributes to keeping short-term yields compressed across the euro area, including the periphery. At the same time, swaps with the same maturity have widened as the market prices earlier interest rate hikes. Demand for collateral will remain strong until the end of the year. However, 2022 opens up to widening risk, as demand for bonds will start to wane, and the front part of the yield curve will shift higher according to interest rate hikes expectations.
However, it looks too early to call for higher yields in the Euro area, as a lot still depends on yields in the US and December's ECB meeting. Suppose more governments across the euro area impose lockdown measures. In that case, the central bank might look to extend the PEPP bond-buying program after March, compressing yields further. The next few weeks preceding Christmas are going to be critical to set direction in European sovereigns.
Economic calendar:
Monday, the 22nd of November
- Spain: Balance of Trade
- United States: Chicago Fed National Activity Index, Existing Home Sales (Oct), 2-year Note Auction, 5-year Note Auction
- Eurozone: Consumer Confidence Flash (Nov)
Tuesday, the 23rd of November
- Germany: Markit Composite, Manufacturing and Services PMI Flash (Nov)
- Eurozone: Markit Composite and manufacturing PMI Flash (Nov)
- United Kingdom: market/CIPS Composite, Manufacturing and Services PMI Flash (Nov)
- United States: Markit Manufacturing PMI flash (Nov), NY Fed Treasury Purchases TIPS 7.5 to 30 years, 2-year FRN Auction, 7-year Note Auction
Wednesday, the 24th of November
- New Zealand: Interest Rate Decision, RBNZ Press Confidence
- France: Business Confidence
- Germany: Ifo Business Climate (Nov), 15-year Bund Auction
- United States: Durable Goods Orders (Oct), GDP Growth Rate QoQ 2nd Est (Q3), Continuing Jobless Claims, Corporate Profits QoQ Prel (Q3), Durable Goods Orders (Oct), Goods Trade Balance (Oct), Initial Jobless Claims, Jobless Claims 4-week Average, retail Inventories Ex Autos (Oct), Core PCE Price Index (Oct), Michigan Consumer Sentiment Final (Nov), PCE Price Index (Oct), Personal Income (Oct), Personal Spending (Oct), FOMC Minutes, 4-week and 8- week bill auction
Thursday, the 25th of November
- New Zealand: Balance of Trade
- Japan: Foreign bond Investment, Coincident Index Final, Leading Economic Index Final (Sep)
- Germany: GDP Growth Rate YoY Final (Q3), GfK Consumer Confidence (Dec)
- Sweden: Monetary Policy Report, Riskbank Rate Decision
- France: Unemployment Benefit Claims
- Canada Average weekly earnings YoY
Friday, the 26th of November
- Australia: Retail Sales MoM Prel (Oct)
- South Korea: Interest Rate Decision
- France: Consumer Confidence
- Switzerland: GDP Growth Rate YoY (Q3)
- Italy: Business Confidence (Nov)
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