Fixed income market the week ahead

While at the beginning of last week, the market was expecting slightly more than two rate hikes in 2022, today, it is pricing marginally less than two. Yet, we still anticipate rate hikes expectations to advance by the end of the year as inflation accelerates, and it becomes apparent it will not be transitory. Therefore, we stick to our 2% target for 10-year US Treasury yields by the end of 2021.

The US Treasury is selling 3-year Notes today, 10-year bonds tomorrow and 30-year bonds on Wednesday, after the inflation report. It will be critical to see if the appetite for US Treasuries continues to remain strong despite the recent drop in yields.

European sovereigns: yields will resume their rise despite the ECB will keep dovish.

Dovish sentiment arising from the FOMC and Bank of England meetings forced investors to reconsider speculations about the ECB hiking interest rate in the next couple of years. The periphery was the biggest beneficiary of the rally, with 10-year BTPS yields spiking to 1.28% at the beginning of the week and then dropping back below 1% by Friday.

What's concerning is how BTP yields rose fast amid fears that the ECB would begin to exit its PEPP program, of which Italy has been the primary beneficiary. It shows how the periphery's fiscal spending continues to depend on the ECB quantitative easing. We doubt the central bank will ever pull support from the third European biggest economy. However, volatility might continue to affect trading activity within this area. This week Italy is selling 3-year and 7-year bonds. Today, it is selling BTP Futura, a retail BTPs issuance, which pays a “fidelity premium" in eight years and at maturity, depending on the country's economic growth. We expect these issuances to price smoothly despite rates having dropped substantially. Yet, it's safe to assume that Italian yields and European peers will need to reprice higher in the long term. Indeed, we expect the German election to bring better European integration and more fiscal spending, translating in higher Bund yields and spread compression across the euro area.

Also, inflationary pressures emerging in the labour market could translate into more persistent core inflation, implying that European yields will need to increase.

Despite the recent setback, which saw 10-year Bund yields dropping below -0.25%, we still believe that there is room for Bund yields to resume their rise to 0% by the end of the year as a traffic light coalition looks likely to form the next German government.

Today the Eurozone Sentix exceeded expectations, hinting at a positive twist for the economy. Tomorrow's German ZEW survey will add more context, although it's safe to assume that the growth rate will decelerate next year.

Gilts: 30-year auction in focus

A rally in Gilts last week was inevitable. The market was pricing much more aggressive interest rate hikes than in the US. However, the drop in yields we witnessed exceeded any expectations. Despite this time around, the BOE was able to push forward interest rate hikes expectations; it's impossible not to envision the central bank going down this road before the economy overheats. Yet, the market might be still overestimating the pace of tightening, pricing four interest rate hikes next year. Therefore, this week growth data, together with a slowdown related to industrial and manufacturing numbers, might further push back hikes expectations, provoking another drop in yields.

On Wednesday, the DMO sells 30-year Gilts through an auction. It will be critical to see if demand remains strong despite yields from 1.55% in October to 1%, a level not seen since August.

Economic calendar

Monday, the 8^th of November

• Japan: BOJ Summary of Opinions, Preliminary Coincident Index and Leading Economic Index (Sept)
• United States: Consumer Inflation Expectations, 3-months and 6-month Bill Auction, 3-year Note Auction, NY Fed Treasury Purchases 22.5 to 30 year

Tuesday, the 9^th of November

• New Zealand: Electronic Retail Card Spending (Oct)
• Japan: Bank Lending (Oct), Current Account (Sept), Foreign Exchange Reserves (Oct), 30-year JGB Auction, Eco Watchers Survey Current and Outlook (Oct)
• United Kingdom: BRC Retail Sales Monitor (Oct), 30-year Gilt Auction
• Germany: Balance of Trade (Sept), 2-year Schatz Auction
• France: Balance of Trade (Sept)
• Eurozone: ZEW Economic Sentiment Index (Nov)
• United States: PPI (Oct), 10-year Bond Auction, NE Fed Treasury Purchases TIPS 7.5 to 30 years

Wednesday, the 10^th of November

• Australia: Westpac Consumer Confidence Index, Building Permits Final (Sept)
• China:  Inflation Rate (Oct), PPI
• Germany: :  Inflation Rate Final (Oct), 10-year Bund Auction
• Eurozone: ECB Non-Monetary Policy Meeting
• Italy: Industrial Production (Sept)
• United States: MBA Mortgage Applications, Inflation Rate (Oct), Continuing Jobless Claims, Wholesale Inventories, NY Fed Treasury Purchases 7 to 10 year, 30-year Bond Auction

Thursday, the 11^th of November

• Japan: Foreign Bond Investment, PPI (Oct)
• Australia: Employment Change, Unemployment Rate, Full-time Employment Change
• United Kingdom: GDP 3-month Average (Sept), GDP Growth Rate (Q3), GDP YoY (Sept), Balance of Trade, Construction Output, Industrial Production (Sept), Manufacturing Production (Sept), NIESR Monthly GDP Tracker
• Italy: Inflation rate
• United States: 4-weeks and 8-weeks Bill Auction

Friday, the 12^th of November

• Australia: Consumer Inflation Expectations
• United Kingdom: Labour Productivity
• China: New Yuan Loans
• Eurozone: Industrial Production (Sept)
• United States: Michigan Consumer Sentiment preliminary (Nov), Michigan 5-year Inflation Expectations Prel (Nov), Michigan Consumer Expectations Prel (Nov), Michigan Current Conditions Prel (Nov), Michigan  Inflation Expectations Prel (Nov)