Fixed income market: the week ahead

In Europe, market conditions are becoming worrying for the European Central Bank, which has vowed to keep government bond yields stable. It's clear that the correlation between German Bunds and US Treasuries is strong, and it will hardly be kept close to zero by increased purchases under the Pandemic Emergency Purchase Programme (PEPP). The biggest problem the central bank is facing is the scarcity of Bunds, which explains why the ECB is careful to boost purchases under the PEPP program. According to the Central Bank's capital allocation key’s rules, roughly 25% of the QE purchases have to be in German sovereign debt. However, the market is running out of Bunds, and Germany is not willing to increase its debt-to-GDP ratio. Therefore, in case of a localized selloff, the ECB selloff might not have adequate tools to contain the crisis. In a recent analysis, we see conditions building up for another European sovereign crisis as rotation from the European sovereigns to the US safe-havens becomes appealing. 

It might be something that the former president of the ECB, Mario Draghi, understands well, and that's why he decided to issue more debt while markets are accommodative. Italy has already spent more than EUR 130 billion to support the economy from the COVID-19 pandemic, and now it will increase the bill by EUR 40 billion.

We believe that the market will binge on Italian debt without problems for the simple reason that there is no other alternative in the euro area. Greek sovereigns offer a higher yield but are rated junk and highly illiquid, posing a considerable threat to bond investors. On the other hand, liquidity in Italian sovereigns is good, and the sentiment is remarkably positive. While European sovereigns have recorded an average loss of 2% since the beginning of the year, BTPS recorded a loss of only 1% as Draghi entered Italian politics. Yet, the most important quality of Italian debt is coupon income amid a yield-starved bond market. Last week’s issuance of a new 50-year benchmark has seen order books over EUR 64 billion. Such extraordinary demand can only be explained by the fact that the bonds were priced with a coupon of 2.15%, which is one of the highest in the euro area. For real money, long-term investors such as insurances and pension funds make more sense to be invested in a 50-year maturity in Italy at 2.15% (IT0005441883) than France at 0.5% (FR0014001NN8). The French 50-year benchmark issued in January is already down 15% as interest rates changes continue to erode the bonds’ value amid extremely high duration.

Tomorrow Italy is to issue 3-, 5- and 15-year bonds. We believe that if demand is strong, Italy might consider issuing bonds beyond 50-year maturities as the cost of funding continues to be extraordinarily low, and the government will be able to lock in a conveniently low yield.

Economic Calendar

Monday, the 12^th of April

• China: Foreign Direct Investment, M2 Money Supply
• Eurozone: Retail Sales
• Canada: Bank of Canada Business Outlook Survey
• United States: 3- and 10-year Note Auction, Fed’s Rosengren speech, Monthly Budget Statement

Tuesday, the 13^th of April

• New Zealand: NZIER Business Confidence
• Australia: National Australia Bank’s Business Confidence
• China: Trade Balance
• United Kingdom: Trade Balance, Industrial Production, Manufacturing Production, Gross Domestic Product, NIESR GDP Estimate, 50-year Bonds
• Eurozone: ZEW survey – Economic Sentiment
• Germany: ZEW survey – Economic Sentiment and Current Situation, 10-year Bond Auction
• Netherlands: 15-year Bond Auction
• Italy: 15-year Bond Auction
• United States: Consumer Price Index, 30-year Bond Auction

Wednesday, the 14^th of April

• Australia: Westpac Consumer Confidence
• New Zealand: RBNX Rate Statement and Interest Rate Decision
• United Kingdom: 30-year Inflation Linkers
• Eurozone: Industrial Production
• Germany: 30-year Bond Auction
• United States: Fed’s Beige Book, Fed’s William Speech

Thursday, the 15^th of April

• Australia: Consumer Inflation Expectations, Fulltime Employment, Unemployment rate
• Germany: Harmonized Index of Consumer Prices
• France: Consumer Price Index
• Italy: Consumer Price Index
• United States: Retail Sales ex-Auto, Philadelphia Fed manufacturing Survey, Retail Sales Control Group, Initial Jobless Claims, Retail Sales

Friday, the 16^th of April

• Eurozone: Eurogroup Meeting, Trade Balance, Consumer Price Index
• China: NBS Press Conference, Industrial Production, Gross Domestic Product, Retail Sales
• United States: Building Permits, Housing Starts