Fixed income market: the week ahead

A rise in US real yields poses a threat to risky assets

We believe there are conditions for yields to rise fast towards the 1.5% level, where they will find strong resistance. Tomorrow, Powell will deliver the semi-annual monetary policy report to the Senate Banking Committee, and it is crucial to understand whether the Federal Reserve is going to let yields rise despite inflation expectations linger. Indeed something alarming is happening: while Treasury yields are rising, real rates are rising with them. It means we might be facing an unexpected rise in capital cost rather than rising inflation, posing an even more significant threat to risky assets. 

Therefore, it becomes crucial to understand whether inflation pressures are growing, which is a question that may be answered on Friday with the release of the Personal Consumption Expenditures (PCE). The Federal Reserve prefers the PCE over the Consumer Price Index (CPI) because it measures the change in the price of goods and services consumed by all households. The CPI focuses on the change in the out of pocket expenditures from households. Economists are forecasting it to be around 1.4%, while it recorded 1.5% in December.

Although we don’t expect the 7-year note auction on Thursday to be particularly telling of market sentiment, it may give some clues on investors’ Treasury appetite amid rising yields.

Will the European Central Bank let European sovereign yields rise?

Across the Atlantic, a key focus is whether the rise in US Treasury yields will continue to provoke a selloff in European sovereign bonds. Since the beginning of February, European sovereign yields moved up by more than 20 basis points. As they continue to rise together with US yields, they will become a headache for the European Central Bank. Although European sovereigns continue to trade at historic low yield levels, if they rise too fast, they might tighten the bloc's economic conditions. Therefore, the ECB might need to intervene again to ease the economy reverting this trend. Lagarde's speech this afternoon is crucial in understanding how the ECB views the rise in yields and whether more monetary stimulus might be expected.

The Ifo Business Climates and Expectations data released today and the GfK consumer confidence data released on Thursday will also dictate sentiment in European sovereigns. The question is whether the bloc's biggest economy is entering into a recovery despite being in a second lockdown since December. Last year, Germany's GDP contracted by 5%, a record since the Second War World.

Troubles in paradise for the periphery?

A potential anti-establishment threat in the periphery seemed to have been put at rest since Mario Draghi entered Italian politics. However, in the past few days, we have seen some troubling events happening in Spain. We believe that in Barcelona, violent protests against the rapper Pablo Hasel's incarceration might lead to a resurgence of the Catalan independence movement. Although at the core of the protest, there is a debate over free speech in Spain, the fact that issues occur in Catalonia, a region that has seen to obtain independence from Madrid, gives an opportunity to "idependistas" to advance their agenda. If that was the case, we might see investors starting to reassess risk in the periphery, starting from Spanish Bonos but leaking to the periphery as a whole. It is key to monitor the Bonos-Bund spread in this environment as any unexpected widening might leak to Portuguese and Greeks Bonds. In this scenario, Italy will remain resilient thanks to the honeymoon provoked by Mario Draghi's entrance into Italian politics.

Economic Calendar

Monday, the 22^nd of February

• China: PBoC Interest Rate Decision
• Germany: IFO Business Climates and Expectations
• United Kingdom: UK Prime Minister Boris Johnson Speech
• United States: Chicago Fed National Activity Index, Fed’s Bowman Speech
• Eurozone: ECB’s President Lagarde Speech

Tuesday, the 23^rd of February

• New Zealand: Retail Sales
• United Kingdom: Claimant Count Rate, ILO Unemployment Rate, Average Earnings Including Bonus, to Sell 2050 Bonds
• Eurozone: Consumer Price Index
• United States: Housing Price Index, Consumer Confidence, 2-year Note Auction, Powell To Deliver Semi-Annual Monetary Policy Report to the Senate Banking Committee

Wednesday, the 24^th of February

• New Zealand: RBNZ Rate Statement and Interest Rate Decision
• Germany: Gross Domestic Product, to Sell 10-year Bunds
• Switzerland: ZEW Survey Expectations
• United States: New Homes Sales

Thursday, the 25^th of February

• Japan: Leading Economic Index
• Eurozone: EU Leaders Summit, M3 Money Supply, Services Sentiment, Consumer Confidence, Industrial Confidence
• Germany: GfK Consumer Confidence
• Italy: 5-year and 10-year Bond auctions
• United States: Durable Goods, Core Personal Consumption Expenditures, Continuing Jobless Claims, Gross Domestic Product, Durable Goods Orders, Non-Defense Capital Goods Orders, Fed’s Williams Speech, US to Sell 7-year Notes

Friday, the 24^th of February

• New Zealand: Trade Balance
• Japan: Tokyo CPI, Retail Trade, Industrial Production
• Eurozone: EU Leaders Summit
• Switzerland: Gross Domestic Product, KOF Leading Indicator
• United States: Core Personal Consumption Expenditure, Personal Income, Personal Spending