Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Government bonds rally amid dovish bets but remain at risk from tomorrow's CPI numbers
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Since Friday's nonfarm payrolls, investors started to unwind their short position, causing the long part of the yield curve to shift lower. The bet is for central banks to keep dovish amid mixed macro data. Yet, tomorrow CPI numbers may force the market hand if monthly inflation numbers exceed expectations. In Europe, yields are falling on the same assumption; however, today's 30-year 0% coupon Bund auction showed that investors keep suspicious of duration despite the tailwind coming from the bond rally.
Today government bond yields are dropping fast on both sides of the Atlantic as investors are positioning ahead of the ECB meeting tomorrow and the Federal Reserve monetary policy decision next week. The shift in positioning in the longer part of the yield curve started last week as nonfarm payrolls disappointed expectations. The straightforward thinking here is that a nonfarm payroll miss leads to lower inflation, thus "lower for longer" interest rates as central banks will extend their accommodative stance until the job market doesn't recover completely. There is also a rising feeling that tomorrow's CPI numbers will undershoot estimates. Some point to lumber falling 30% from its peak at the beginning of May. Yet, investors fail to see that lumber prices are still the highest they have even been at any point in history.
To weigh on yields today are also discussion regarding Biden's infrastructure plan, which seem to find opposition by centrists, thus less likely to pass.
The market might be right into believing that central banks may be keeping monetary policies accommodative in the short-term, but we think it is wrong in expecting that CPI numbers undershooting expectations.
Tomorrow we will be focusing on monthly core CPI numbers. April’s core inflation rose to 0.91%, the highest monthly reading since 1981. The monthly data for May is expected at 0.5%. Although expectations are lower than last month, we have to consider that any surprise in this number may indicate that prices are rising faster and might keep high for a considerable time. Remember, while yearly data are transitory, there is nothing to suggest that monthly data are.
Even though today we have seen 10-year US Treasury yields breaking below the tight range they have been trading since March, a surprise in CPI data tomorrow may mean today’s gains might reverse.
Looking at the 10-year yield chart, we see that yields have broken below their 100 days simple moving average, they will find support at 1.40%, but if they break this level too, they may fall as low as 1.20%
Don't be fooled. Yields may point lower in the short term, but from a long-term perspective, there is the only way where they can go: higher.
The same can be said about German Bund yields. Today the German Finance Office issued 30-year 0% coupon Bunds. Amid the dovish expectations for tomorrow’s ECB meeting and dropping yields across the eurozone, today’s Bund auction’s results are somewhat troubling. The lowest-accepted bid ended up to be at 91.25, the lowest since January last year and the second-lowest since 2011.
It indicates that although the auction benefitted from tailwinds coming from the bond market's rally, investors continue to treat duration risk with suspicion.
To cut it short, things are not so rosy for bonds as today’s rally might be suggesting.
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