Fixed income market: the week ahead

European sovereigns yields retreat, but there is still trouble ahead as Italian government bonds yields remain higher than Greece's.

European sovereign yields are falling following Friday's Ms Lagarde comments. The ECB president said that the central bank remains committed to maintaining favourable financial conditions throughout the pandemic period, sending a dovish message that weighs on European sovereign yields. On top of it, purchases under the PEPP program have increased to roughly EUR 80 billion net purchases per month, the highest since July last year.

Economists point to the fact that the ECB should relax and look at the rise in yields favourably as the macroeconomic backdrop strengthens with the reopening of the economy. Indeed, the rise in German Bund cannot be attributed any longer to an increase in US Treasuries yields because the latter stabilized in the past few months while Bund yields continue to rise. While a lower correlation between US Treasury yields and Bund yields is welcome, another troubling factor cannot be left unnoticed. This month, Italian government bond yields have broken above those of Greece. The move is worrisome because it shows that either the ECB’s various QE programs create distortions within the European sovereign space or that the periphery, including France, is poised to a brutal correction. As explained in last week’s analysis, there is no political concern right now that should wait negatively on the BTPS. Secondly, fears of lack of BTPS’ future issuance demand are unfounded because the ECB will be able to support this issuance, and the higher yield will attract both real money with long term investment horizon and demand from investors looking to park liquidity in the short-term to avoid negative-yielding deposit rates.

Greek government bonds present much higher credit, rotation and liquidity risk compared to their Italian peers. The same can be said about Portuguese sovereigns. French and Spanish government bonds don't present the same liquidity issues; however, they are at significant risk of rotation as they pay less than EUR-hedged US Treasuries.

It reinforces our belief that Italian BTPS are now trading rich and remain much less vulnerable to a repricing as German Bund yields continue to rise. The spread between 10-year Italian BTPS and comparable Bund yields should stabilize around 100bps until fall. Following the German elections, we expect better European integration and higher fiscal spending, which will further compress this spread.

Economic calendar:

Monday, the 24^th of May

• Japan: BoJ’ Governor Kuroda Speech
• United Kingdom: BoE’s Governor Bailey Speech
• United States: Chicago Fed National Activity Index, Fed’s Brainard speech, Fed’s Mester speech, Fed’s Mester speech, Fed’s Bostic speech, Fed’s George speech 3- and 6-month Bill Auction

Tuesday, the 25^th of May

• Germany: Gross Domestic Product, IFO Business Climate, Current Assessment and Expectations
• United States: Housing Prices Index, S&P/Case Shiller Home Price Indices, Richmond Fed Manufacturing Index, New Home Sales, Consumer Confidence, 2-year Note Auction
• United Kingdom: BoE’s Tenreyro speech

Wednesday, the 26^th of May

• New Zealand: Trade Balance, RBNZ Rate Statement and Interest Rate Decision, Monetary Policy Statement and Press Conference
• Japan: Corporate Sector Price index, Leading Economic Index, foreign investment in Japan Stocks, Foreign Bond Investment
• France: Business Climate in Manufacturing, Consumer Confidence
• Switzerland: ZEW Survey – Expectations
• United States:MBA Mortgage applications, Fed’s Quarles speech, 5-year Note Auction
• Canada: BoC’s Lane speech

Thursday, the 27^th of May

• Germany: Gfk Consumer Confidence Survey, German Buba President Weildmann speec
• Switzerland: Trade Balance, Exports, Imports
• Italy: Business Confidence, Consumer Confidence, Trade Balance, 10-year Bond Auction
• United Kingdom: BoE Vlieghe Speech
• United States: Durable Goods, Core Personal Construction Expenditures, Continuing and Initial Jobless Claims, Gross Domestic Product, Pending Home Sales, US Treasury Secretary Yellen Speech, 7-year Note auction

Friday, the 28^th of May

• Japan: Tokyo Consumer Price Index, Unemployment Rate, Construction Orders
• Germany: Import price Index
• France: Gross Domestic product, Consumer Spending, Producer prices’
• Spain: Retail sales
• Italy: Producer Price Index
• Eurozone: Services Sentiment, Consumer Confidence, Industrial Confidence, Business Climate, Economic Sentiment Indicator
• United States: Core Personal Consumption Expenditure, Personal Income, Personal Spending, Chicago Purchasing Manager Index, Michigan Consumer Sentiment Index