Fixed income market: the week ahead

Suppose the dot plot projections show that members are increasingly more hawkish. In that case, we could see yields rising back above 1.5% to find resistance at 1.60%.

However, in the long-term, yields will need to rise. The transitory nature of inflation is subjective, and it depends on the way you look at it. The current spike will be short-lived, and we can expect inflation to normalize by the end of this year or by the beginning of 2022. Yet, the question is at what level it will normalize. Indeed, suppose inflation keeps supported at a much higher level than what we are accustomed to. In that case, the central bank will not have any other choice than to taper and hike interest rates. That’s why it’s crucial to reduce noise and to focus on data that signal whether inflation might keep supported for an extended period. The rise in wages and primary home rentals are pointing to something lasting, even if a great part of the current surge in prices is transitory. The latest CPI numbers show that food away from home has risen, making us wonder whether it is a way for restaurant owners to pay higher wages. We will know more about the transitory nature of inflation in the third quarter of the year. However, for long-term bond investors, it’s key to recognize that there is more downside in holding US Treasuries than upside. Indeed, if 10-year yields drop to 1%, it would represent a capital gain of roughly 4%. Yet, if yields rise to 2.5%, the loss on capital would be 9%, and it could be greater depending on at what level inflation will stabilize.

Rotation poses a threat to European sovereigns

In Europe, the focus will be on the United Kingdom and whether the country will need to extend its lockdown measures in light of rising Covid-19 related cases. The country's vaccination program is well advanced, yet new strains are causing a rise in hospitalization. It could hamper the speed of an economic rebound forecasted by the Bank of England since the beginning of the year.

Last week, 10-year Gilt yields broke below the ascending trading range they have been trading since February, driven by the drop in yields in the US. This morning they are testing their 100 days simple moving average at 0.70%, and if they break below this level, they will find support at 0.65% next. The Debt Management Office will sell 7- and 30- year Gilts tomorrow and 15-year Gilts on Wednesday. Demand at these auctions might give an insight into investors' expectations on the recovery.

News of an extension of a lockdown in the UK could weigh on European sovereigns, too. However, our focus will be on rotation. Recent German Bund auctions showed demand is lacking for these sovereigns. One of the reason might be that we start to see a rotation from European sovereigns to the US safe-heaven. This week the German Finance Agency is issuing 10-year Bunds. Suppose demand in Bund is lagging, but demand is solid at tomorrow’s 20-year US Treasury auction. In that case, it may indicate that investors have started to rotate from lower-yielding European government bonds to US peers.

At the latest 10-year Bund auction, we have seen the bid-to-cover ratio dropping to 1.28x, the lowest since March last year. The lowest accepted bid was 100.9, the lowest since February 2019, showing that for appetite for these securities continues to fall. Rotation will pose a threat not only to Bunds but also to other lower-yielding sovereigns such as France, Spain and Portugal. Italian BTPS will be able to weather losses better as they are currently offering the highest yield in the bloc.

Economic Outlook

Monday, the 14^th of June

• Japan: Industrial Production
• Eurozone: Industrial Production
• United States: 3- and 6-month Bill Auction

Tuesday, the 15^th of June

• Australia: RBA Meeting Minutes, House Price Index
• United Kingdom: Claimant Count Change, ILO Unemployment Change, Average Earnings, 7- and 30-year Gilts Auction
• Germany: Consumer Price Index, Harmonized Index of Consumer Prices, 2-year Note Auction
• France: Consumer Price Index
• Italy: Consumer Price Index
• Eurozone: Trade Balance
• United States: Retail Sales, Producer Price Index, 20-year Bond Auction

Wednesday, the 16^th of June

• Japan: Merchandise Trade Balance Total, Machinery Orders
• China: NBS Press Conference, Industrial Production, Retail Sales
• United Kingdom: Consumer Price Index, Retail Price Index, PPI Core Output, 15-year Gilts Auction
• Eurozone: Labor cost
• Germany: 10-year Bond Auction
• United States: Building Permits, Housing Starts, FOMC Economic Projections, Fed Interest Rate Decision, Fed Monetary Policy Statement FOMC Press Conference
• Canada: Consumer Price Index

Thursday, the 17^th of June

• Australia: RBA’s Governor Lowe speech, Fulltime Employment, Employment Change, Unemployment Rate, Participation rate
• Switzerland: SNB Financial Stability Report, SNB Interest Rate Decision and Monetary Policy Assessment
• Italy: Trade Balance
• Spain: 3-, 5- and 10-year Bond Auction
• Eurozone: Eurogroup Meeting, Conversion Price Index
• United States: Philadelphia Fed Manufacturing Survey, Initial Jobless Claims, 5-year TIPS Auction

Friday, the 18^th of June

• Japan: BoJ Interest Rate Decision and Monetary Policy Statement
• United Kingdom: Retail Sales
• Germany: Producer Price Index
• Eurozone: EcoFin Meeting, Current account