Fixed income market: the week ahead

It’s crucial to understand that although we might be facing a better week for US Treasuries, the bearish trend has been set, and the bond market will continue to be volatile, putting at stake risky assets. It’s nearly impossible to make forecasts about where yields will end up by the end of this year because there is the risk that if the Federal Reserve continues to dismiss the bond market, nominal yields could spike together with inflation expectations provoking serious disruptions.

If the duration event that we are witnessing now intensifies, it can easily pose funding hurdles that the market will pay handsomely. This quarter, US investment-grade credits fell the most since 1981. Their historically high average duration made them more vulnerable to a rise in interest rates than junk bonds. The primary market has been forced to reduce the average maturity of new issuances this quarter pointing to the fact that capital structure is changing profoundly among those sectors that are characterized by above-average duration, such as utilities, telecommunications and technology.  If interest rates continue to rise, there is the risk that the junk credit space will be the next victim. Indeed, many high yield corporate bonds rely on the low cost of funding and a stable market.

The European bond market will continue to focus on US Treasuries this week while more countries are extending and imposing stricter lockdown rules. Germany’s Ifo survey will tell whether business expectations continue to rise or if new lockdown measures start to scare the market. However, the biggest problem in Europe remains the rise in yields in the United States, which are becoming more and more convenient compared to the periphery once hedged against the EUR. Indeed, the US safe-havens offers around 0.85% in yield once hedged against the euro, around the same yield offered by Greece (for more, click here).

This point should be extremely concerning for the ECB because it could trigger another selloff in the periphery, such as the European sovereign crisis. Greek bonds are more at risk of rotation as they are rated junk and mainly held by foreign investors. However, a selloff in Greek sovereigns might leak easily to other countries to the periphery, such as Portugal, which debt is also held largely by foreigners.

In the United Kingdom, data releases will focus on inflation, retail sales, flash PMIs and labour data being released throughout the week. So far, the Bank of England seems to be looking towards the Federal Reserve's same direction anticipating inflation to hit 2% this year as the economy recovers fast amid an efficient vaccination program. The BOE last week said it is committed to keeping rates on hold until the inflation target will be achieved sustainably. Yet the central bank didn't sound concerned regarding the fast rise in Gilt yields, which rose even more exponentially than those of the Treasuries since the beginning of the year. Ten-year Gilts are trading around a resistance level of 0.85%; however, there is the risk that once they break this level, they will rise fast towards 1%, where we believe the BOE will need to pay more attention to their rise as they might start tightening financial conditions.

Economic calendar

Monday, March the 22^nd

• China: PBOC Interest Rate decision
• Japan: Leading Economic Index
• United States: Chicago Fed National Activity Index, Fed’s Chair Powell speech, Fed’s Daly speech, Fed’s Quarles speech, Fed’s Bowman speech
• Germany: Buba President Weidmann Speech

Tuesday, March the 23^rd

• United Kingdom:Claimant Count Change, ILO Unemployment Rate, BOE’s Cunliffe speech, BOE’s Governor Bailey speech
• United States: New Home Sales, Fed’s Chair Powell testifies before Congress, 2-year Note Auction, Fed’s Brainard and Williams speech
• Netherland: 10-year bond auction
• New Zealand: Trade Balance
• Australia: Commonwealth Bank Service PMI

Wednesday, March the 24^th

• United Kingdom: Retail Prices, Consumer Price Index,PPI Core Output, Markit Manufacturing PMI and Services, BOE Monetary Policy Meeting Minutes
• Germany: Markit Manufacturing PMI and Services, 10-year Bond Auction
• Eurozone: Markit Manufacturing PMI and Services, Consumer Confidence
• United States: Durable Goods Orders, Markit Manufacturing PMI and Services, Fed’s Chair Powell testifies before Congress, Fed’s Williams speech, 5-year Note Auction

Thursday, March the 25^th

• Germany: Gfk Consumer Confidence Survey
• Switzerland: SNB Interest Rate Decision, SNB Monetary Policy Assessment
• Eurozone: M3 Money Supply, Economic Bulletin
• United Kingdom: BOE’s Governor Bailey speech
• United States: Continuing Jobless Claims, Gross Domestic Product, Core Quarterly PCE, Initial Jobless Claims, Fed’s Clarida speech, Fed’s Williams speech, 7-year Note Auction

Friday, March the 26^th

• Japan: Tokyo Consumer Price Index
• United Kingdom: Retail Sales
• Germany: IFO Business Climate, Current Assessment and Expectations
• United States: February Core PCE, Michigan Consumer Sentiment Index