bond market

The US 2-year yield fell sharply, while the S&P500 ended flat after hitting a fresh high since last summer on optimism that the US will finally agree to raise the debt ceiling.     The House will vote today to decide whether the debt limit bill gets approved at time to get a Senate approval by next Monday deadline.     The deal between Biden and McCarthy freezes discretionary spending for the next two years, which excludes weighty plans like Medicare or social care, and will only have a minor impact on around $20 trillion budget deficit projected for the next decade. Frozen spending means a spending cut in real terms as long as inflation remains high. The higher the inflation, the higher the spending cut in real terms.   But the problem is that at least 20 conservative Republicans of the House rejected Kevin McCarthy's compromise on debt ceiling, saying that spending cuts are not enough. One hardcore Republican, Dan Bishop of North Carolina, threatened to vote to oust McCarthy because he 'capitulated' to Democrats. Democrats, on the other hand, are not fully happy either as they don't want to freeze or to cut spending.     This is what a compromise is: accepting something without being fully satisfied to avoid a self-induced world economic crisis!    Anyway, any misstep at today's House vote could send the US yields higher and stocks lower.     So far, there has been a widening gap between the way the stock and bond markets priced the threat of a US government default. While the US sovereign bonds cheapened across the board, and violently at the short end, stock investors were confident that a ceiling deal would be reached and weren't discouraged by the rising US yields to stop buying.     And even the fact that the Federal Reserve's (Fed) hawkish stance has a material impact on yields' upside trajectory since the bank-stress dip, stock markets kept on climbing. Looking at how Nasdaq behaved since the bank stress rebound in yields, you could barely guess that there are rate-sensitive stocks in it.    But the reality check is that Nasdaq stocks are rate sensitive, and cannot be rate-hike proof if the Fed continues hiking the rates. It would, however, also be a good thing for the Fed members to consider pulling some liquidity out of the market as the Fed's balance sheet is still worth more than before the bank crisis.    What if Russia refuses to cut output?  In energy, US crude tanked nearly 5% yesterday, and tipped a toe below the $69 pb mark on worries that Russia may not follow OPEC's output cuts, in which case the internal conflict may prevent the cartel from reducing supply in a way to give a jolt to oil prices.   There is little chance that we see the kind of discord like back in 2020, as the Ukrainian war strengthen the ties between two allies. But any Russian veto could materially reduce OPEC's power of hit on oil prices.    Elsewhere, the Chinese manufacturing PMI showed that contraction in activity accelerated in May instead of stepping back to the expansion zone. The faster Chinese manufacturing contraction also weighs on the sentiment this morning.     We shouldn't expect China to post growth numbers comparable to levels pre-2020 because China under Xi Jinping's rule is willing to avoid euphoric, and unhealthy growth.   This is why the government put in place severe crackdown measures on real estate, tech and education. That does not mean that China won't get back in shape, but recovery will likely take longer, and growth will likely be more reasonable and a better reflection of the reality of the field.    

FX strategy (with Frantisek Taborsky, EMEA FX & FI Strategist) HUF has been the clear winner YTD in the CEE region thanks to the subsiding energy crisis and very attractive carry due to the extreme high interest rate environment. Despite the first rate cut, HUF did not weaken thanks to the NBH’s transparent communication, which we expect will continue to remain as transparent as it has been so far this year.   We expect that the market will continue to favour the forint, which will continue to maintain a significantly higher carry within the region in the second half of the year. In our view, the playing field for the forint will be in the range of EUR/HUF 368-378 in the coming months and we target 372 for the end of the year.   Thus, we do not see much room for a move lower from current levels, which is supported by the very long positioning of the market. This will prevent further gains in the forint. We can still expect the NBH monetary policy and EU money story to be the main drivers. Higher volatility will remain in the market in the second half of the year and we may see some seasonal FX weakness especially during the summer months. However, market expectations for EU money are rather cautious and so we do not see room for a big sell-off, similar to that at the end of last year over this issue. Moreover, we should see a deal ultimately being agreed between the EC and the Hungarian government. Overall, we continue to like the forint and the NBH normalisation story. We expect investors might use any EUR/HUF spike to build new positions in forint and benefit from the significant carry.   FX – spot and INGF   Evolution of gross external debt (% of GDP)   Fixed income strategy (with Frantisek Taborsky, EMEA FX & FI Strategist and James Wilson, EM Sovereign Strategist)   The market is pricing in a large portion of NBH monetary policy normalisation, but we believe that the region's fastest disinflation and a record strong forint will support further market bets on policy easing. Our bias remains for a lower and steeper curve.. On the bond side, despite fiscal risks, we see this year's funding fully under AKK's control. HGBs post the highest gains within the region YTD, supported by the NBH's successful normalisation story and government measures.   On the other hand, HGBs are getting expensive after the recent rally. In the hard currency space, current valuations look about fair for REPHUN, with spread levels towards the wider end of the BBB tier.   Headline risk remains high amid the ongoing EU fund negotiations and geopolitical noise, which mean there are potential upside and downside catalysts, and volatility will remain elevated. Meanwhile, fundamentals are recovering from last year’s energy shock, in particular on the external accounts. Further FX issuance is likely later in the year, with the AKK guiding for a potential benchmark size EUR issue, in part to prefinance for 2024.   Local curve (%)   Public debt redemption profile (end-Mar 2023, HUFbn)

Despite the fact that the European Central Bank has much more reasons to consider lowering interest rates compared to the Federal Reserve, the ECB not only raised the refinancing rate but Lagarde practically stated that there would be another rate hike in July. This decision not only contradicts expectations but also goes against common sense to some extent. Of course, this resulted in the dollar's decline, thereby reducing the pressure caused by its apparent overbought condition. However, the European economy is facing serious difficulties associated with the increased cost of energy resources.   The European industry suffers the most. Many, including in the West, are already openly calling what is happening the deindustrialization of Europe. And a strong dollar may somewhat alleviate this negative trend. So, the decisions and intentions of the ECB are more harmful than beneficial to the European economy. Especially considering that inflation in the euro area is slowing down as fast as in the United States. Today's inflation report should confirm the fact of its slowdown from 7.0% to 6.1%. And don't think that the ECB was unaware of this yesterday because we are talking about final data.   The preliminary assessment was already available two weeks ago. In such a situation, the most reasonable approach would have been not to touch interest rates and observe the developments for at least two or three months.   Frankly speaking, the ECB's actions are raising more and more questions. And this naturally leads to an increase in concerns, which are usually referred to as uncertainty risks. Investors typically try to stay away from such risks. Therefore, the euro's substantial growth, which pulled the pound along, is likely to be unsustainable and probably won't last long. The GBP/USD pair has surged in value by nearly 300 pips since the beginning of the trading week.     This movement has resulted in the extension of the medium-term uptrend. Take note that such an intense price change has triggered a technical signal of the pound's overbought conditions. On the four-hour chart, the RSI is at its highest level since autumn 2022, indicating a technical signal of overbought conditions.   On the same timeframe the Alligator's MAs are headed upwards, which points to an upward cycle. Outlook In this case, speculators are disregarding the overbought status, as evidenced by the sustained momentum and the absence of a proper correction. However, this process cannot persist indefinitely, and sooner or later, there will be a liquidation of long positions, leading to a pullback. Until then, traders will consider the psychological level of 1.3000 as the main resistance level.  

With US markets closed, markets in Europe underwent a weak and subdued session at the start of the new week with yesterday's declines predominantly on the back of the late Friday sell-off in the US, which saw markets there close off their highs of the week. The lack of any further details on a China stimulus plan, along with additional upward pressure on interest rates over uncertainty about further rate rises, and a slowing global economy, saw European investors engage with some modest profit taking.     Asia markets were mixed this morning, even as the People's Bank of China cut its 1 and 5 year lending rates by a modest 10 bps.     The UK gilt market was the main source of movement in the bond market, with 2-year yields pushing up to their highest level in 15 years, while 5- and 10-year yields came close to the highs we saw at the end of September last year, after the Kwarteng budget.       There is growing anxiety about the effect the recent rise in UK gilt yields is already having on the mortgage market, a concern that was played out in the form of weakness in house building and real estate shares yesterday, as 2-year mortgage deals pushed above 6%.     It is also feeding into a wider concern that economic activity in the second half of the year will be constrained by increased mortgage costs, which in turn will push up rents as well as shrinking disposable income.     All eyes will be on tomorrow's inflation numbers with Bank of England policymakers praying that we start to see rapid slowdowns in how fast prices are rising before the end of the summer.     While prices have been slowing here in the UK they have been slowing more rapidly in the US as well as in Europe, although in Europe they also fell from much higher levels.     Today we get the latest Germany PPI numbers for May which have been slowing sharply from peaks of 45.8% back in August, and had come down to 17.6% by January this year. In today's numbers for May it is expected to see annualised price growth slow further to 1.7%, while seeing a -0.7% decline month on month.     Another monthly decline in today's numbers would be the 7th monthly decline in the last 8 months, in a sign that disinflation is working its way through the system, and could also manifest itself in this week's UK PPI numbers as well.     The puzzle is why it is taking so long to bleed into the headline CPI and core CPI numbers, though it could start to by the beginning of Q3. The Bank of England will certainly be praying it does. As we look towards today's European open its likely to be a modestly higher one.          EUR/USD – have slipped back from the 1.0970 area having broken above the 50-day SMA at 1.0880 which now acts as support. We still remain on course for a move towards the April highs at the 1.1095 area.     GBP/USD – slipped back from 1.2845/50 area with support now at 1.2750 which was the 61.8% retracement of the 1.4250/1.0344 down move. If we slip below 1.2750, we could see further weakness towards 1.2680. Still on course for a move towards the 1.3000 area.      EUR/GBP – remains under pressure and on course for further losses toward the 0.8470/80 area. Currently have resistance at 0.8580 area and behind that at 0.8620.     USD/JPY – still on course for a move towards the next resistance at 142.50 which is 61.8% retracement of the 151.95/127.20 down move. Above 142.50 targets the 145.00 area. Support now comes in at 140.20/30      FTSE100 is expected to open unchanged at 7,588     DAX is expected to open unchanged at 16,201     CAC40 is expected to open 7 points lower at 7,307

Stocks have tried to deny reality since the Fed made it clear in multiple statements there is zero chance of the Fed returning to looser monetary policy this year and every chance of it taking interest rates higher one or two more times before the end of the year.     Stocks have also being trying to ignore the immediate bond reality that took over when the debt ceiling was lifted, setting the US Treasury free to transform the bond market by selling bonds as quickly as elephant ears at a fair or ice-cream on a hot day at the beach. The chart above shows how earnings from stock-traded companies have slowly settled as yields from bonds have soared to where the risk premium between stocks and bonds has disappeared. That means pushing risky stock prices even higher when Treasuries provide equal risk-free earnings makes no sense. And the two are just now crossing over to where they will make negative sense ... as in like opening an ice-cream cart at the North Pole....  

Global manufacturing hubs; South Korea, Singapore & China continued to indicate a weaker external demand environment. Several key stock markets; US & Japan are on bullish footing, ignoring global recession risk. Higher US consumer confidence & more positive earnings guidance are required to maintain the bullish animal spirits. Higher cost of funding & a deeply inverted US Treasury yield curve are key hurdles for the bulls. The great divergence continues between the state of the real global economy and risk assets such as equities. Latest data from key global manufacturing hubs in Asia have indicated more potential weakness ahead in the external demand environment for the second half of 2023. South Korea, a key provider of semiconductors and smartphones for the global economy saw its latest full monthly exports figure decline to -6% year-on-year in June, a lower magnitude of -15.2% recorded in May but lower than expectations of a 3% drop. Overall, it’s nine consecutive months of contraction for South Korea’s exports. In addition, soft data from South Korea’s Manufacturing PMI which tends to have a lead time over exports figures has remained in contraction mode for twelve consecutive months; it fell to 47.8 in June from 48.4 in May. Data from China’s Caixin Manufacturing PMI which provides coverage for small and medium enterprises fared slightly better than the official NBS Manufacturing PMI for June but remained lackluster; it dipped to a neutral level of 50.5 from 50.9 recorded in May and came in slightly above expectations of 50.2. Singapore’s non-oil domestic exports (NODX) slumped by 14.7% year-on-year in May, worse than forecasts of an 8.1% decline after a 9.8% reading in April; so far it has marked its eighth consecutive month of contraction.   US Nasdaq 100 and Japan Nikkei 225 were star performers in H1 2023   Fig 1: Key cross-assets performances as of 30 Jun 2023 (Source: TradingView, click to enlarge chart   Fig 2: Nasdaq 100 long-term secular trend as of 30 Jun 2023 (Source: TradingView, click to enlarge chart) In contrast, several major benchmark stock indices have continued to shrug off these “real negative growth backdrop”, entered bull market territories, and staged stellar performances. The top performer was the US Nasdaq 100 assisted by the Artificial Intelligence (AI) equity theme play rocketed to a gain of 38.75% in the first half of 2023 and outperformed the MSCI All-Country World Index which recorded a positive return of 13.03% over the same period. Japanese equities also performed well in the first half; the Nikkei 225 rallied by 27.19%, and the bulk of H1 2023 gains came from Q2 (+18.36). Thanks to a change in corporate governance that favoured shareholders’ activism, lower valuation over the US stock market, and rosy foreign funds’ inflows reinforced by prominent value investor, Warren Buffet’s increased stakes in several major Japanese trading firms made over the first six months.     In contrast, other Asian stock markets in general have been trapped in a muted tone due to a slowing China economy after a diminished growth spurt from the removal of stringent Covid-19 lockdown measures and rather lukewarm monetary and fiscal stimulus measures being implemented at this juncture. The MSCI All Country Asia ex-Japan has managed to score only a meagre gain of 2.55% in the first half, which still has a significant gap to cover to recoup its annual loss of -21.66% posted in the prior year. Over in Europe, Germany’s DAX managed to squeeze an H1 2023 return of 15.98% but do take note the bulk of its gain came in Q1 as the lackluster external growth environment has triggered a negative ripple effect where the DAX’s Q2 performance only stood at 3.32% that’s a huge gap of around 1,180 basis points over Nasdaq’s Q2 return of 15.16%. Markets are always forward-looking, around the end of Q1 2023, the bullish camp for equities had a “Fed Pivot” narrative where there were significantly high odds being priced into the Fed funds futures market that advocated rate cuts of 75 bps to 100 bps in the second half of 2023. Right now, given the Fed’s latest monetary policy guidance is to have “higher interest rates for longer periods”, rate cuts pricing in the futures market for H2 has evaporated, and even though further hikes may not be implemented in 2024 after two more hikes on the Fed funds rate that are being priced in before 2023 ends to bring its likely terminal rate to 5.50% to 5.75%, the start of an easing cycle may only kick in during the second half of 2024 based on latest data from CME FedWatch tool at this time of the writing. Thus, with the liquidity punch bowl being taken away for now. What are the possible catalysts that can continue to drive the positive animal spirits in the US stock market that can increase the odds of spreading to the rest of the world?   Higher consumer confidence and better-than-expected earnings guidance So far, US consumer confidence has been trending up modestly since July 2022. The final June reading of the University of Michigan Consumer Sentiment Index has been revised higher to 64.4, its highest level in four months. Higher consumer confidence tends to lead to higher consumer spending in the US where the US consumers may take on a similar pre-pandemic role of the “global consumer” for goods and services. Q2 2023 earnings reporting season in the US will go full fledge in around two weeks. Based on FactSet data as of 30 June 2023, its estimated earnings decline compiled from analysts for the S&P 500 is at -6.8% year-on-year, a further drop from Q1’s -2% y/y. The key will be the number of positive earnings forward guidance from the cyclical sectors such as Industrials and Consumer Discretionary to take over the baton from Information Technology. So far, there is more positive earnings guidance for FY 2023/2024 in Industrials as the mix is 65% positive and 35% negative whereas else Consumer Discretionary share of positive guidance is only 48% (52% negative).   Higher cost of funding and a deeply inverted US Treasury yield curve are key hurdles for the bulls The bond market seems to be not “buying” into the H1 2023 bullish narrative seen in the stock market. On the last trading day of H1, the US Treasury yield curve spread (10-year minus 2-year) continued to invert deeply to -1.06%, its lowest level since March during the onset of the US regional banking turmoil which indicates an increase odd of a hard landing in the US economy coupled with a higher level of interest rates environment for a longer period that can drive up the cost of leverage and borrowings for corporates and depress profit margins. If such a scenario materializes, current lofty bullish expectations in the US stock market may see a swift downward adjustment that is at risk of spreading to the rest of the world, and to prevent such occurrences, perhaps China needs to implement more aggressive expansionary monetary and fiscal policies to fill up the liquidity punchbowl given that inflationary pressures are benign in China.  

US stock market closes at 1 p.m. and the bond market closes at 2 p.m. EST  and will stay closed for the Fourth of July. US ISM Manufacturing index contracts for an eight straight month Tesla shares pop on robust Q2 delivery data The start of the second half of the year is not doing much for US stocks as most of Wall Street is in holiday mode for the Fourth of July.  Today’s shortened trading session saw traders focus on strong electric vehicle data from Tesla and a weak ISM Manufacturing report.      ISM The headline manufacturing reading fell to 46.1, the eight straight contraction and weakest reading since May 2020.  The ISM manufacturing report showed a large price drop with prices paid and the employment component fell into contraction territory.  Prices paid fell from 44.2 to 41.8, the lowest levels in a year.  The news was not all bad as new orders rose from 42.6 to 45.6.  The dollar tumbled following the ISM report that might suggest manufacturing activity is getting close to finding a bottom.  Fed swaps saw a lower peak rate following the softer manufacturing report.  Student Loan Debt The Supreme Court delivered a big blow to millions of students that were hoping to have up to $20,000 of loan debt wiped away.  The Biden administration was hoping to get a major win with the $1.8 trillion student loan crisis. They will now scramble to formulate a new plan that will give students a break before the federal student loan payments are due in October.  This could be a noticeable hit to the economy as these students haven’t had to make payments since the pandemic began.  Biden announced a one-year ramp on loan repayments, which is probably just the beginning of pledged efforts to help students.  This will likely become a campaign issue for Biden.    Tesla It shouldn’t come as a surprise that Tesla posted a record number of deliveries in the second quarter after all the price cuts, a resilient US consumer and a decent performance in China. Tesla delivered 466,140 vehicles in Q2, much better than Wall Street’s expectation of 448,350 cars.  When it comes to analysts ratings, Tesla mostly has buy and hold ratings, but that might improve following these results.  BYD also posted robust sales in China, topping Volkswagen for the first time.  Volkswagen was king in China for the past 15 years, so this overtaking is a key changing of the guard moment for BYD.  China has gone all-in with electric vehicles and that is benefitting Tesla and BYD.     

Inflation front and centre this week as China slips towards deflation By Michael Hewson (Chief Market Analyst at CMC Markets UK)   European markets underwent a shocker of a week last week, posting their biggest declines since March, despite a modest rebound on Friday. With economic data continuing to look on the soft side and central banks showing little sign of easing up when it comes to interest rate rises there was little to cheer for markets in Europe, with concerns about weakness in the Chinese economy adding to the gloom.   US markets on the other hand, while still finishing the week lower, still managed to perform better after a slightly weaker than expected non-farm payrolls job report, which showed that the US economy added 209k jobs in June, down from 306k in May. There was also a 2-month net revision lower of -110k, taking some of the lustre off recent gains, and removing some of the euphoria around the ADP jobs number of 497k, the day before. The unemployment rate still fell to 3.6%, while average hourly earnings growth came in unchanged at 4.4%, which was at a slightly higher level than expected. One thing that we were able to take away from last week was that further rate rises from the Federal Reserve as well as the European Central Bank are almost certain when they both meet in 2 weeks' time, however there is now rising concern that we may see further rate increases after that in September as well.     The bond market is certainly reflecting the fact that rates are likely to stay higher for longer after the yield curve steepened as 10-year yields outperformed 2-year yields on a week-on-week basis.   With earnings season set to get underway in earnest over the next week or so, there is increasing nervousness that after such a good first half of the year, that the second half of the year is likely to be much more challenging.   What last week's economic data also tells us is that while the economy in Europe could well be set to contract for the third successive quarter in succession, the US economy appears to be holding up reasonably well There is a fear however that central banks are on the cusp of a serious policy mistake when it comes to their determination to drive inflation lower. We already know that inflation has been slowing sharply over the last few months, and we also know that PPI inflation in China and Europe is now in negative territory.       This morning we saw that inflation in China slowed even further in June with headline CPI coming in at 0%, and PPI slipping from -4.6% in May to -5.4% That alone suggests that the rate hikes that have already been implemented over the past 15 months have had an effect, however such is the nature of monetary policy, and the way interest rate markets have changed over the last 20 years, with many more fixed rate loans, there is no way of telling how much more tightening has yet to come through.     This should make central bankers much more cautious, however it seems to be having the opposite effect, causing frustration that inflation isn't coming down quickly enough, due to resilient consumption patterns. With US CPI for June set to be released on Wednesday, and PPI on Thursday we are likely to see further evidence of this disinflationary trend, even while wages growth remains resilient. These are the key macro items for investors to mull over this week ahead of the Federal Reserve later this month, while in the UK tomorrow we have the latest wages and unemployment numbers for the 3-months to May, which are expected to show strong wages growth against a backdrop of a tight labour market.           EUR/USD – broke higher last week after finding solid support around the 1.0830/40 area. We need to see a move above the June highs at 1.1010/15 to target a move towards 1.1100, and the highs this year. A break below the lows last week opens the way for a potential move towards 1.0780.     GBP/USD – broke above resistance at the 1.2770/80 area putting it on course for a move towards the 1.3000 area, but needs to take the 1.2850 area and June highs first. Support comes in at the 1.2770/80 area, and below that at 1.2680.      EUR/GBP – continues to find support at the 0.8515/20 area and June lows. Also has resistance at the 0.8570/80 area. We also have resistance at the 50-day SMA which is now at 0.8635. Below 0.8500 targets 0.8460.     USD/JPY – fell below the 144.00 area triggering stops all the way to the 142.00 area, also falling below support at 142.50. Posted a weekly reversal suggesting the top is in and the risk of a return to the 139.80 area. We need to see a move back above 142.80 to stabilise and argue for a return to 144.00.       FTSE100 is expected to open 3 points lower at 7,254     DAX is expected to open unchanged at 15,603     CAC40 is expected to open 14 points lower at 7,098  

FX Daily: US Treasury wobble unnerves risk assets A sell-off at the long end of the US Treasury market has cast a shadow over risk assets and hit cyclical currencies. The dollar has been the main beneficiary. Expect focus to very much remain on the US bond market into next week's quarterly refunding. For today, attention is on whether the BoE hikes 25bp or 50bp and how Brazilian assets react to the 50bp rate cut.   USD: Tracking Treasuries Wednesday's session was all about the US bond market and the sell-off at the long end of the curve. US 30-year Treasury yields were briefly 15bp higher. And far from the benign bullish disinversion of the curve we saw after the soft June CPI print, yesterday's move was a more negative bullish steepening. Higher risk-free rates hit US growth stocks (Nasdaq -2%) and also hit 'growth' currencies, such as the commodity complex and the unloved Scandi currencies. At the heart of yesterday's move was the US fiscal story. Despite the Democrat administration and its supporters in the media decrying Fitch's decision to remove the sovereign's AAA status on Tuesday evening, there is genuine concern over US fiscal dynamics. And it looks like the Fitch release was carefully timed. Yesterday also saw a slightly higher than expected US quarterly refunding announcement, where $103bn of 3, 10, and 30-year bonds will be sold next week. The fact that fiscal dynamics were in play yesterday was reflected in wider US asset swap spreads (Treasuries underperforming the US swap curve) and the US yield curve steepening. As above, higher risk-free rates are providing greater headwinds to risk asset markets - including equities. We are also seeing some slightly higher cross-market volatility readings which may prompt investors to partially de-risk from carry trade strategies (good for the Japanese yen and Swiss franc on the crosses, bad for the high yielders). We will also be interested to see how the Brazilian real performs today after Brazil's central bank started its easing cycle last night with a 50bp cut and promised similar magnitude cuts over coming meetings. The currency could edge a little lower today given the international environment. While the US Treasury story will be with us into next week's auctions, the focus today will be on the initial jobless claims (these have been moving markets) and the services ISM index. Barring a significant rise in claims or a big dip in the services ISM, it looks like the dollar will hang onto recent gains into what should be a decent US July nonfarm payrolls report tomorrow.    DXY could grind its way toward the 103.50 area.  

Sustainability-linked products will likely remain a useful tool for the future, but their growth will have to be accompanied by a general increase in company interim sustainability target setting, as well as more rigorous sustainability data reporting.   Stronger government issuance growth, but corporate ESG bond shows resilience There is also a stark difference in issuance between the public and private sectors. The growth in the first half of 2023 is almost exclusively coming from governments, whereas all analysed sectors but the technology sector saw drops in the first half of 2023 compared to the second half of 2022.   Global sustainable finance issuance by sector   Nevertheless, despite the large role of government entities in supporting sustainable finance market growth, for ESG bonds only, corporate issuance is still showing resilience when compared with the broader bond market. Excluding sovereign, supranational, and agencies (SSAs), the share of ESG bond issuance as a percentage of total bond issuance slid slightly from 2022’s record of 10.6% to 10% for the first six months of 2023. It’s probable that this percentage can still increase for the rest of the year.   In terms of product type within different sectors, there has been a major shift in product preference towards UoP instruments as discussed earlier. This change is seen across all regions and across almost all industries, including the energy, consumer discretionary, utilities, and technology sectors we analysed below, except for industrials and healthcare, for which there are rather limited options for use of proceeds financings at this point.   For green bonds, issuance has either been sustained at a somewhat flat level or increased in the energy, consumer discretionary, and utilities sectors, while it registered a decline in the technology sector. The direction of travel in green loan issuance is more mixed, with the energy and technology sectors seeing an increase and the consumer discretionary and utilities sectors experiencing a decrease. All this has in general resulted in green products taking up a larger share of these sectors’ issuance volumes.   Issuance of sustainable finance products in selected sectors   Only around a quarter of S&P 500 companies have issued one or more sustainable finance products. S&P 500 companies in the Energy and Healthcare sectors have the lowest sustainable finance adoption rate, at 9%, whereas companies in the Utilities sector have the highest, at 83% followed by the Real Estate sector, at 65%. Hard-to-abate sectors, such as Energy, Material, and Industrials, have relatively low adoption rates. This demonstrates the dual-challenge for hard-to-abate sectors: effectively lowering emissions and showcasing the credibility of their sustainable finance products. 

Rates Spark: Energy and food inflation is ringing more alarm bells Suddenly some inflation alarms are ringing again: energy and food prices are under rising pressure, as are market inflation expectations. We'll get US CPI today, which will paint a picture for July. What's beyond that is becoming a little more nuanced and troubling for bonds.   US inflation ahead is key, but so also are the wider impulses which can trouble bonds There is heightened discussion on where we are with inflation. While the US CPI reading is key for the near term, there is also an acknowledgement that inflation expectations coming from the market discount have become a little less anchored than they had been. The 5yr * 5yr inflation rate has returned to the 2.5% area, and the inflation swaps measure of the same has it up in the 2.7% area. These are not awful levels when you consider where inflation was, and at least these expectations are still comfortably below 3%. But it’s the path they’ve been on that creates the issue, as that path has been pointing upwards. At the same time, there is an ongoing rise in food and energy prices in play, which risks adding to headline pressure down the line. Given this backdrop, the US 10yr has managed to remain above 4%, and we think it should continue to do so. And remember, once we get through tomorrow’s US inflation report, we’ll likely see headline US inflation closer to 3.5% than 3% and core US inflation closer to 5% than 4%. There’s been progress made to the downside, but the burning issue for bonds is whether the inflation threat has actually been dealt a death blow. Based on the market expectations for inflation, it hasn’t. For that reason, we stick to our cautious approach to bonds, eyeing higher yields. We also remain under considerable supply pressure this week. Decent US 10yr auction yesterday. Minor tail, virtually none. High indirect bid, and reasonable cover. Not as good as the 3yr. But it did not tail, as some had feared. The 30yr auction is up next.   Market's long term inflation expectations still trended higher     Risk to inflation outlook also sets floor to EUR rates In the eurozone, the upward leg in the longer-term inflation swaps over the past weeks up until the latest correction has been even more striking. Although other measures, such as the European Central Bank surveyed consumer inflation expectations, have displayed further moves in the right direction earlier this week, the recent swings in the price for natural gas also highlight the lingering risk of supply disruptions to the more benign inflation dynamics of late. The ECB may have sounded less determined at the last meeting, not having pre-committed to a hike in September. But one should not underestimate the ECB’s resolve and persistence. Markets are still seeing a 70% chance for one more hike, even if a bit later than September. Further out, though, there is already a full discount of three 25bp cuts over 2024, which suggests not too much room for pricing in more.   Collateral scarcity remains a sensitive topic Bunds moderately cheapened relative to swaps on the back of an ICMA official’s opinion that the ECB would not follow the Bundesbank’s lead in cutting the remuneration of government deposits at the central bank to 0%. That would mean starting in October, only the roughly €50bn sitting at the Bundesbank would be impacted, but not the remaining around €200bn with other national central banks. Until October, the actual impact of the Bundesbank’s changes will remain a source of uncertainty and likely keep Bunds asset swap spreads elevated, but countering collateral scarcity fears are the ECB’s ongoing quantitative tightening, which was accelerated last month and the prospect of higher-than-anticipated issuance from Germany itself. Headlines to that end came from the government which announced yesterday that it was ramping up its climate fund from €30bn to €212bn from 2024 to 2027.      Bundesbank's government deposits are not the largest   Today's events and market view US CPI is key today. Expected are an increase to 3.3% in the headline and only a marginal decrease to 4.7% in the core year-on-year rates. This still means that the Fed’s inflation target is some distance away, although month-on-month readings of 0.2% for both headline and core point to more encouraging dynamics recently. The other release that has seen larger market reactions in the recent past is the initial jobless claims. Especially since the last official jobs data was a mixed bag, a more contemporaneous reading might get more weight to gauge the state of the jobs market. That said, consensus is looking for little change with 230k this week compared to last week’s 227k figure. Fed speakers Bostic and Harker are scheduled to speak on the topic of employment later today. In supply, the US Treasury caps off this week’s supply slate by auctioning US$23bn in a new 30Y bond.

2-year Treasury yield rises 3.7bps to 4.979% (supports Fed’s higher for longer push) Dollar softens as risk appetite tentatively returns following last week’s stock market rout Fed Chair Powell to speak at Jackson Hole Symposium on Friday The fate of the dollar will not solely depend on what Fed Chair Powell says at Jackson, but on several other factors. Will Nvidia’s earnings reignite the AI trade and provide much needed relief to tech stocks? How much additional support will we see from China? Is ECB President Lagarde ready to show which way she is leaning towards for the September meeting? Finally, will the global flash PMIs show that rate hiking cycles are starting to bring down the service sector? Fed Chair Powell will be trying to avoid a policy mistake here. The annual Jackson Hole gathering will undoubtedly emphasize the need for policymakers to keep rates higher for longer.  Powell might stick to his hopes of a soft landing, while hinting that eventually rates will be able to come down.  It seems the majority of Wall Street is expecting Powell to deliver a hawkish hold, but any signs that the Fed is concerned about disorderly markets could end up supporting the case that the Fed will cut rates early next year. EUR/USD Daily Chart     The EUR/USD (a daily chart of which is shown) as of Monday (8/21/2023) is seeing its bearish trend cool ahead of the Jackson Hole Symposium.  The euro’s slide had its eyes on the July low (1.0834), but that seems to be providing key support for now.  If the bond market selloff remains intact, we might not have to wait for any fireworks from Jackson Hole speeches by both ECB’s Lagarde and Fed Chair Powell.     If euro-dollar sees a sharp plunge, key support will come from the 1.0740 to 1.07400 region. It is around that area that price could see the formation of a potential bullish ABCD pattern, which might target a key harmonic level of 350 pips. The key story on Wall Street remains the movement with real yields.  The yield on 10-year inflation-protected Treasuries rose above the 2% level, this is the first time it did that since 2009.  Soft landing or not, some investors won’t be able to pass up getting paid over 5% on short-term debt they can hold for a few months. If at the end of the week, the dollar’s rally is exhausted, upside could target the 1.0925 region.  Only a daily close above the 1.1050 level would open the door for an extended euro rally.    

US Treasury yields continue to rise, with 2-year bonds exceeding 2% for the first time since 2009, the 10-year rate at its highest since 2007, and 30-year T-bonds setting a record.   On the one hand, the increase in Treasury yields indicates a decrease in risks, as a sell-off in bonds means a sell-off in risky assets. On the other hand, the burden on the US budget increases, and inflation expectations can grow again at any time. The risks on the path of inflation moving to the target level remain high.   The main threat to New Zealand and Australia is China's economic slowdown. Financial stress is increasing, and there are signs that China is heading towards a full-blown financial-economic crisis. The Chinese authorities have tools to prevent such an outcome, but a slowdown in GDP growth is almost inevitable, resulting in a decrease in foreign trade volumes. NZD/USD As expected, the Reserve Bank of New Zealand left the rate at 5.5% at the meeting that ended last week. The tone of the accompanying statement unexpectedly gained an additional hawkish tilt due to a slight increase in the rate forecast (by 9bps). The GDP and inflation forecasts changed little, but the updated OCR track from 0.25% indicates that the RBNZ does not consider the current level as sufficiently restrictive as it did three months ago.     The risks for the New Zealand economy are diverse and to some extent offset each other, but in some cases, they intensify. High net migration is a good thing for the labor market, as the increase in labor supply will raise the unemployment rate but simultaneously allow wage growth to be contained, an essential criterion in the fight against inflation. At the same time, domestic demand is getting weaker, despite the influx of migrants. Exports fell by 14% YoY in July, while a decrease of only 4% was expected.   Imports fell by 15% (forecast 8%), partly due to lower global commodity and goods prices. On Thursday, a quarterly retail trade report will be published, which will serve as the basis for the forecasts for consumer demand. The net short position in the NZD increased by $123 million during the reporting week to -$145 million. Market positioning remains neutral with a slight bearish bias. The price is certainly falling, with no signs of a reversal.   A week earlier, we identified the support zone of 0.5870/5900 as a target, the pair has reached this target, and from a technical perspective, a bullish correction is possible. The nearest target is 0.5975, followed by 0.6010. At the same time, the primary trend remains bearish, so in the long term, after the corrective phase has ended, we expect another wave of sales, with the target being the support zone of 0.5830/50.     AUD/USD Australia's economic calendar for the week is calm, with no significant economic reports to take note of. The next week will be much more saturated - on August 29, Reserve Bank of Australia Deputy Governor Michele Bullock will speak, and we can look forward to several reports, including the monthly Consumer Price Index for July, retail sales, and investment dynamics for the 2nd quarter, which will allow a preliminary assessment of GDP growth rates. The RBA rate forecast assumes another increase in November, as the RBA will likely respond to rising business costs, rent, and energy prices. Inflation is declining more slowly than in the United States. The net short position in the AUD increased by an impressive $620 million over the reporting week and reached -$3.45 billion, with market positioning firmly bearish. The price is below the long-term average but has lost momentum, suggesting an attempt at a corrective phase.  

In the FX  The EURUSD remains offered below its 200-DMA today, although the softening Federal Reserve (Fed) expectations make more sense than softening ECB expectations, provided that the ECB is NOT in a comfortable place to call a pause at this month's meeting amid the uptick in latest inflation figures. Therefore, if the ECB expectations, which may have softened unnecessarily are restored into the next ECB meeting, we should see the EURUSD find a solid ground before the critical 1.0615 Fibonacci support.   On the flip side of the world, the Reserve Bank of Australia (RBA) kept its cash rate unchanged at 4.1% at today's monetary policy meeting. The EURAUD rebounded from a month-dip as investors saw opportunity to trade the soft RBA stance versus a possibly unfunded softness in ECB expectations, which justifies a further upside correction in the EURAUD toward the 1.70 mark – especially when the news from China remains disquieting.  Elsewhere in the Pacific, Japan is testing the market demand for its 10 and 30-year bonds this week, as the finance ministry sells 2.7 trillion-yen worth of 10-year bonds today and 900-billion-yen worth of 30-year bonds on Thursday. Of course, the Bank of Japan (BoJ) is out and buying a massive amount of bonds to make sure that the YCC not too relaxed, and traders are looking for signs of still sluggish demand from local investors that could force the BoJ to act earlier than ... never. The Japanese 10-year yield is currently at a 9-year high, but is still below 65bp, meaning that it has ways to strengthen. However, when the Japanese yields will become interesting enough for domestic Japanese investors - which are also among the biggest buyers of US papers, the returning home will apply a decent pressure on the US long term yields.  

Rates Spark: Close calls EUR rates have drifted higher, contemplating the chances of further ECB tightening. Returning US markets today could extend the momentum of the late Friday sell-off while busy issuance could add to the upward pressure. Eventually data decides for how long 10Y UST yields can be supported in the 4 to 4.25% area, with eyes this week on tomorrow's ISM services.   With the US out for Labor Day, EUR rates drifted higher at the start of the week with the usually more policy-sensitive belly of the curve in the lead. European rates' main focus remains the ECB, given the proximity of the next meeting and given that it's the final chance officials have to communicate their policy preferences ahead of the quiet period. ECB President Lagarde’s speech yesterday yielded little concrete information regarding the ECB's  next steps –  even though the speech centred around the importance of communication. She did remark that “action speaks louder than words”. While she was arguably talking more about what the ECB has already achieved, hiking rates by 425bp over a relatively short time span of 12 months, the comment surely resonates with the ECB’s hawks' current thinking about the upcoming decision. Over the weekend the ECB’s Wunsch already opined that "a bit more" tightening was necessary. Bundesbank’s Nagel delved into more technical matters around the ECB’s decision to end the remuneration of banks' minimum reserves. He argued that more should be done on reserves – if via not rates, it seems some hawks are ready to consider other options for tightening financial conditions. Important inputs to the upcoming decision are measures of expected inflation. Market based measures, such as the 5y5y forward inflation swap, have recently come off their peaks but remain mired in relatively elevated territory. The aforementioned 5y5y forward is still close to 2.6%. As ECB's Schnabel noted in last week's speech this is also a reflection of growing uncertainty surrounding the longer inflation outlook and could in turn reflect slowly eroding credibility of the ECB’s commitment to get inflation to 2%. Today the ECB will release its consumer survey which has seen 3y median inflation expectations already drop from 3% at their peak to 2.3% as of June. That is also ready close to 2%, but before the turmoil of 2022 median expectations were usually even closer to 2%. The June survey results also pointed to a more pronounced tail in the distribution, towards higher inflation outcomes.   The last ECB hike had little traction further out the curve

Rates Spark: Slowly gearing up to the key events Markets are gearing up to this week’s main events. It is not just about this Thursday’s ECB meeting, but also about crucial data in the US and UK ahead of next week’s respective central bank meetings. Front-loaded issuance is helping to keep rates elevated, but we also expect hawkish risks to make a bearish case for rates this week.   Front end themes developing in a bear-steepening environment With central banks seen to be approachig their tightening cycle peaks it is only natural that the upcoming meetings are in the spotlight, kicking off with the ECB decison this Thursday.  With regards to central bank communications both the ECB and the Fed are in the pre-meeting black-out periods but we did hear from the BoE’s most hawkish member Catherine Mann yesterday, who noted that it was best to err on the side of further tightening. With regards to the market pricing of the BoE decision outcome, we have seen a notable shift towards the sense that the end of the tightening cycle is nearing. The implied probability for a hike next week had slipped below 80% at the end of last week – late last month the market was still more than fully pricing a 25bp hike.  The main focus in the US this week is still on data however, with the  August CPI release tomorrow. Our economist has flagged the risk of the month-on-month core inflation rate accelerating slightly. While that won’t move the needle for next week’s Fed decision, where a pause is widely anticipated, it would indicate hawkish risks to the broader Fed outlook. The market is attaching a 50% chance to another Fed hike by year-end.      Front loaded corporate issuance activity ahead of the events, especially in the US, is keeping upward pressure on rates. Markets will also have US Treasury supply in mind, where we saw a softer 3Y auction yesterday. The 10Y and 30Y reopenings follow today and tomorrow. It is a similar story in Europe, where we also saw the EU announcing a 7Y deal and – with greater market impact – the UK announcing a syndicated reopening of a 50Y Gilt which weighed on the long end of the curve.     10Y yields are again approaching the upper end of recent ranges

An alluring entry point for income seekers Income-seeking investors should prepare to identify entry points as central banks’ policy tightening peaks. As we are entering into a volatile environment, balancing duration and credit risk will be pivotal. Moreover, as uncertainty keeps volatility in bond markets elevated, our preference is to keep duration at a minimum. Short duration markets, which are the most sensitive to central banks’ policies, offer above-average income opportunities. Even if rates rise further in the near future, the yield offered by high-grade bonds is enticing for buy-and-hold-investors. The spread offered by investment-grade corporates with maturity between one to three years over the US Treasuries is 62bps, paying an average yield of 5.04%. According to the Bloomberg US Aggregate Bond Index, that’s the highest yield paid by high-grade bonds with such short maturity since 2007. More strikingly, IG corporate bonds with one to three years’ maturity offered an average yield of 1.8% from 2007 to today. Similarly, high-grade euro corporates with one to three years of maturity pay 4.43%, the highest yield since the 2011 European sovereign crisis, paying 280bps over the past fifteen years’ average. The yield offered by corporate bonds in the UK is much higher than in the United States and Europe. Although for buy-and-hold investors further BOE rate hikes might not represent a threat, it’s important to note that credit risk in the UK is higher than anywhere in developed economies due to uncertainty surrounding inflation and future monetary policies agenda. Thus, cherry picking in this space is even more critical.     Not only corporate bonds offer enticing returns Recent government bond issuance shows that risk-free alternatives to the corporate bond market or even stocks offer good opportunities. In June, the UK debt management office (DMO) sold five-year notes with a coupon of 4.5% and a yield of 4.932% (GB00BMF9LG83). That’s the highest coupon offered on five-year notes since 2012, and the highest yield since 2008. Similarly, the US Treasury issued two-year notes in June with a coupon of 4.25% (US91282CHD65). Also, the German Bund sold in April (DE000BU3Z005) pays a coupon of 2.3%. That’s quite staggering if we think that a few years ago, it would have paid a coupon of 0%, providing a negative yield to investors.     Artificial Intelligence and the bond market: the great deflation In an AI economy, increased productivity and job displacement will exacerbate income inequality. It translates into bigger fiscal deficits as governments initiate education initiatives and social safety nets. As unemployment rises and inflation drops, monetary policies will become more accommodative, with the possibility of negative rates becoming the norm. Yet, the new regime will come with increased inflation volatility. To avoid that, policy makers will be incentivised to regulate AI and use it selectively in order not to destroy the real economy, producing milder economic effects.

US stock futures trade steady after a tech share led rise on Monday, while European stock futures trade higher ahead of UK jobs data and EU and German sentiment surveys. The dollar has stabilised after falling by the most in two months after Japan and China signaled willingness to take steps that would support their currencies. Elsewhere, US Treasuries hold steady following Friday’s slump with focus on a heavy issuance calendar and Wednesday’s CPI which is expected to show a monthly acceleration to 0.6% amid higher energy prices. Crude near the highs of the year with traders awaiting monthly reports from OPEC and EIA while gold continues to test support. The Saxo Quick Take is a short, distilled opinion on financial markets with references to key news and events. Equities: The Nasdaq 100 index led US stocks higher on Monday with Tesla jumping 10% after Morgan Stanley upgraded the stock. Key events in equities this week to watch are Arm IPO (Wednesday), Adobe earnings (Thursday), ECB rate decision (Thursday). The US inflation report on Wednesday is also a potential market mover if inflation surprises to the upside. FX: The retreat of the US dollar brought strong gains across the G10 board although dollar gains came back slowly overnight. The Japanese yen saw strong gains on the back of weekend Ueda comments that brought forward expectations of policy normalization. USDJPY dropped to lows of 145.91, coinciding with fresh recent peaks in JGB yields, before a rebound back to 146.50+ levels as US CPI is awaited. Yuan also strengthened with USDCNH briefly dropping below 7.30 from highs of 7.36+ amid verbal warnings from authorities, better-than-expected credit data as well as the continued appreciation bias in PBoC’s daily fixings. Commodities: Crude extended its rally on Monday as the dollar softened, and the fuel sector recorded strong gains amid continued tightness. Focus on monthly oil market reports from OPEC and EIA with gains being led by the fuel products. Strong performance in metals led by iron ore up 3.5% and copper up close to 2.5% with China credit data and a stronger yuan boosting sentiment. Gold trades in a tight range between the 200- and 50-day moving averages with moves in the dollar and yields the focus ahead of US CPI on Wednesday. Finally, a harvest pressured grains sector awaits a monthly supply and demand report from the US government. Fixed-income: This week, the bond market will focus on inflation data, US Treasury auctions, and the ECB rate decision. Yesterday’s 3-year Treasury note sale attracted little demand, with indirect bidders falling to the lowest since October 2022. The auction tailed by one basis point for the first time since June as investors expect the Federal Reserve to keep rates higher for longer. Today, the Treasury will sell $35 billion 10-notes. Overall, we remain cautious, favoring the front part of the yield curve over a long duration. Bonds will gain as the economy starts to show signs of deceleration. Still, larger coupon auction sizes and a hawkish BOJ will support long-term yields unless a tail event materializes. We still see 10-year yields rising further to test strong resistance at 4.5%. Volatility: Options volumes on Tesla have been exceptionally high over the last 2 trading days. With volumes of over 3 million option contracts per day it’s almost double of the normal volumes, while the implied volatility of Tesla is also rising, building up towards its earnings release next month. The broader market saw another day of decline in the VIX, currently at 13.80, and the VIX futures having touched their lowest since January 2020. Macro: US NY Fed inflation expectations rose higher for one-year to 3.6% from 3.5%, while the long-term five-year also rose 0.1ppt to 3.0% from 2.9%. However, the three-year expectations dipped to 3.8% from 3.9%. In the news: China’s PBoC asks banks to get approval for dollar purchases over USD50 million (Reuters), EU Commission cuts euro zone growth forecast as Germany in recession (Reuters), Representatives from eight core member institutions of the China National Forex Market Self-regulatory Mechanism met on Monday to discuss about maintaining the stability of the renminbi (Xinhua), Strong demand pushes Arm to close IPO order book early (FT), Qualcomm strikes new Apple deal on 5G chips (FT), US and Vietnam unveil billions in semiconductor and AI deals (FT) Technical analysis: The author is away Macro events: UK jobs report (Aug) est. 30k vs 97k prior (0600 GMT), Ger ZEW Survey (Sep) est –15 vs -12.3 prior (0900 GMT), US 10-year T-note auction ($35 billion) Commodities events:  EIA’s Short-term Energy Outlook (1600 GMT), USDA’s World Agriculture Supply and Demand Estimates (1600 GMT), OPEC’s Monthly Oil Market Report (During the day), API’s Weekly Crude and Fuel Stock Report  

Budget deficit reduction is mindful of growth The Union budget this year set what has been described by some as an "unambitious" target for deficit reduction, taking the targeted deficit to 5.9% of GDP down from 6.4% in the fiscal year ending March 2023. It might be fairer to describe this budget as one aimed at growth, containing a lot of capital expenditure measures aimed at bolstering India’s infrastructure, with an assumed goal of “crowding in” private business expenditure. In that respect, judging by the run of GDP so far this year, it seems to be succeeding. India’s sovereign credit rating of BBB- puts it precariously at the edge of investment grade and leaves the bond market vulnerable to downgrade risk. Those fears seem to have been allayed with the recent announcement of global bond index inclusion for Indian government bonds.    India's deficit - on track so far   So far as India’s progress in gradually reducing the deficit and its debt-to-GDP ratio, things seem to be roughly on track this year, and maybe a little ahead of the game. In order to hit the 5.9% deficit ratio, and assuming real GDP growth of around 7% and inflation averaging about 4%, India’s cumulative deficit needs to come in at about INR 16.9tr by March next year. So far, the monthly deficit figures have kept close to the projected “on target” track required to achieve this, and there seems little danger of any credit downgrades on this basis, with the debt-to-GDP ratio still high but likely to moderate to about 81.5% by the end of this fiscal year, down from 83.8% last year.        External balance and the INR One of the surprises of the year so far has been the resilience of the rupee. Since October 2022, the INR has inhabited a very narrow range against the USD, between about 80.5 and 83.0. Over recent months, the range has been narrowing, centred on 82.5. To put this into perspective, this makes the INR the third best-performing currency in the APAC region year-to-date and represents a substantial outperformance relative to other APAC FX peers, where, for example, the Japanese yen is 11% weaker, and the Chinese yuan 5.84% weaker against the USD.     Policy rate spreads over USD and FX performance

... as well as in EUR The bear steepening is not confined to the US. In Europe the 10y Bund yield briefly pushed past 2.8% and the 30y hit 3%. Interesting to note is that this happened with longer term inflation expectations actually dropping, so entirely real rate driven. Risk assets of course are not liking it. In European sovereign space this has seen Italian bond spreads over Bunds prolonging their widening leg, taking the 10y spread to 186bp today. But overall widening was a moderate 2bp in relation to the 5bp outright move today, also considering it was largely directional widening since the start of this month. But at the same time that widening over the past week also happened alongside implied rates volatilities coming down, which should normally support spread products. Implied volatility has picked up a tad over the past few sessions but still remain at their lowest since June. In part, it may be the explanation why Bund asset swap spreads (ASW) have remained relatively tight as they mirrored that broader move. That is still notable though, as a lot of the factors traditionally driving the Bund ASW are on the move, and pulling in different directions. Risk sentiment as measured by sovereign spreads has been one factor, but its influence seems muted, with other risk measures like volatility being down. The European Central Bank’s chatter about quantitative tightening has become louder, but the additional effective net supply that a speedier unwinding of the ECB’s bond portfolios implies may take more time to actually realise. More near term, supply could actually still drop, when the German debt agency updates its quarterly funding plan today. And starting next week government deposits currently still sitting on the Bundesbank’s balance sheet will no longer be remunerated and could hence push into the market for high quality collateral.   10Y yields are on long term highs, but the curves still have room   Today's events and market views The data calendar for the US already gets busier with the releases of house price data, new home sales numbers and the Conference Board consumer confidence survey as highlights today. The European data calendar has less on offer but we will see quite a few ECB officials making public appearances, including chief economist Lane and Austria’s Holzmann. Government bond primary markets will stay busier with a 10Y tap out of the Netherlands, a 5Y tap from Germany and Italian short term plus linker auctions. The main highlight will probably be the release of the German fourth quarter funding plan with cuts to the issuance target expected. The UK taps its 10y green Gilt and the US Treasury sell a new 2Y note.

EUR: Back-end yield premium weighing on the euro The 10bp tightening in the EUR/USD 2-year swap rate differential on Friday was completely erased on Monday, with the spread once again at a -120bp level. Such a wide gap was observed in two other periods in 2023 – at the very beginning of January and throughout February and March. Interestingly, EUR/USD never traded below 1.0500 in those periods, a testament to the back-end US-yields premium currently adding pressure on the pair. The Bund-UST 10-year spread has widened by nearly 60bp since mid-June, now at a -177bp low as seen in November 2022. Latest CFTC figures on speculative positioning suggest EUR/USD still had some residual net-longs (+14% of open interest) to be unwound, and the ever-deteriorating rate gap with the dollar means that 1.0400 may well be tested this week. As discussed above, swings in the volatile bond market will likely determine when that can happen. In a recent note, we estimated EUR/USD would fall to the 1.02 area should 10-year yields hit 5.0%. Domestically, the eurozone data calendar is empty today, but we’ll hear from a few European Central Bank speakers, including Philip Lane and Francois Villeroy.

Rates Spark: Turning into a rout This bond bear steepening market is being driven by Treasuries, and more specifically by higher longer tenor real rates. This is painful for corporate borrowers, as higher real rates cannot be diversified away through higher prices (as could be the case if driven by inflation expectations). This puts pressure on credit markets as a result.   Too far, too fast? It's messy out there. It's not often you get a 10bp uplift in the 10-year yield in one day. We had one yesterday. And we've had over a 50bp upmove in the past three weeks. It's now at 4.8%, and looking like it's gone too far too fast. But if we don't look down, that 5% level could be with us quite quickly. It's clear also that Treasuries are a dominant driver out there. It's pulling other yields higher, is hurting equities, and is pretty immune to influence from risk off. Typically, a severe enough risk-off event would put some counterflows back into Treasuries. And there have been some. Right through the rise in yields in the past couple of months there have, in fact, been net inflows into Treasuries. But this has not been enough to dominate price action. In fact, prices have moved first, not so much in reaction to flows, but in anticipation of them. And of course in reaction to data that continues to show the US economy continuing to defy recession worries. The JOLTS data are a case in point. This measure of "job openings" had been coming off the pandemic sugar high which saw them peak out in the 12 million area. A huge level. It compares with a long-run average in the 2.5 million area. It had been falling since mid-2022, and got to below nine million last month. But the latest month shows a pop back up towards 10 million (9.6m). That's a remarkable move in light of the inflation/rates/sentiment headwinds that arguably should be impacting the economy more. And the curve continues to pull steeper (dis-inversion). As we ended the summer, the 2/10yr was in the -75bp area. It's now half that, and just 35bp away from breaking back above zero into positive territory. It's been pulled there by higher longer tenor real rates. The 10-year real yield is now knocking on the door of 2.5%, having been below 2% only a few weeks back. And importantly, inflation expectations are broadly steady. This angst mode has been driven entirely by higher real rates, and signs of underlying macro strength. Note, however, that higher real yields are also more painful than ones driven by higher inflation. The latter can be passed on through higher prices at the corporate level. But higher real rates are more difficult to "pass on". They are essentially a tax on the borrower that must be paid to get any type of re-funding done. That is arguably where the next vulnerability lies. Risk assets are reacting to this, but there is the potential for more pain here ahead, especially in the guise of wider credit spreads.   Real rates are pushing higher

Credit Supply Outlook: The Collection Credit supply forecasts are mixed for 2024. We expect higher supply in EUR corporates and financials, ESG supply, high yield and Real estate supply. However, we forecast lower Reverse Yankee supply, corporate hybrid supply and covered bond supply. Meanwhile, USD corporate supply should remain stable.   We forecast €310bn in EUR corporate supply in 2024 We are forecasting a minor increase in corporate supply in 2024, but overall low supply. The main driver of this increase is the rise in redemptions from €246bn up to €260bn. Thus, net supply remains low at just €50bn. The technical picture, therefore, remains strong.   Net supply remains low in 2024   Why we expect a small increase in supply but overall low supply: Higher for longer rates Rates are likely to stay at these elevated levels for some time and come down slowly. Our rates strategists expect EUR rates to move mostly sideways in the coming year, with EUR 10-year swap rates only dipping towards 3% by the middle of next year from around 3.25% currently. As such, funding costs remain very high. However, in saying that there has been a strong preference for issuers to hold off new issuance until next year in an attempt to get cheaper funding with the expectation of rates falling.   Less availability of credit and equity With tighter lending standards, less available bank liquidity and banks looking to reduce exposure to risk, many corporates will be pushed towards the bond market. This adds some additional supply pressure, particularly in certain segments of the market. Additionally, there is now a lack of access to IPOs, LBOs and private equity, further putting pressure on corporates' ability to refinance.    Expect disintermediation trend to remain We expect a small increase in supply due to the continuing disintermediation trend. As shown in the chart below, there has been a trend of more disintermediation over the past ten years. 2023 is likely to function like 2012 and 2016 when supply increased following a year of low bond supply relative to loan supply (ratio of loans-to-bonds in 2012, 2016 and 2022 all increased, breaking the disintermediation trend due to market volatility but rebounded the subsequent year).    

US Federal Reserve keeps its options open with another hawkish hold The Fed funds rate target range was held at 5.25-5.5% by a unanimous vote, with a hawkish tone retained to ensure financial conditions remain tight and aid in the battle to constrain inflation. Higher household and corporate borrowing costs are starting to bite though and we don’t expect any further hikes this cycle.   Rates held with a hawkish bias retained No surprises from the Federal Reserve today with the Fed funds target range held at 5.25-5.50% for the second consecutive meeting – the longest period of no change since before the tightening cycle started in early 2022. The accompanying statement acknowledges the “strong” economic activity – a slight upgrade on the “solid” description in September while there was explicit mention of “tighter financial and credit conditions”, which will weigh on the economy. Nonetheless, in the press conference Chair Powell recognises that the economy is starting to see the effects of tighter monetary policy, but that the committee still has a bias towards more hikes rather than seeing the prospect of cuts on the horizon. This is understandable since the Fed does not want to give the market the excuse to significantly backtrack on the recent repricing of “higher for longer” policy interest rates. While there does appear to be a slight softening in the degree of hawkishness the Federal Open Market Committee (FOMC) is expressing, they are careful not to provide a signal that policy has peaked, which could tempt traders to drive market rates lower in anticipation that the next move would be rate cuts. Such action could potentially reignite inflation pressures, but we doubt it.   Peak rates with cuts on the horizon for 2024 The surprise surge in longer-dated Treasury yields and the tightening of financial conditions it’s prompted will inevitably create more headwinds for activity in an environment where mortgage and car loan rates are already above 8% and credit card interest rates are at all-time highs. With Treasury yields staying at elevated levels, the need for further policy rate hikes is dramatically reduced and we do not expect any further Fed rate hikes. Consumer spending remains the most important growth engine in the economy, and with real household disposable income flat-lining, savings being exhausted and consumer credit being repaid – and this is before the recent tightening of lending and financial conditions is fully felt – means we see the primary risk being recession. If right, this will depress inflation pressures even more rapidly than the Fed is anticipating, giving it the scope to cut policy rates in the first half of next year.   Bond yields falling into the Fed meeting more to do with less (relative) supply pressure on the long end The bond market went into the FOMC meeting in a decent mood. The refunding announcement was deemed tolerable, partly as the headline requirement of US$112bn was US$2bn lower than the market had expected. Note, however, that 10yr issuance increases by US$5bn (to US$40bn) and 30yr issuance increases by US$4bn (to US$24bn), while 3yr issuance increases by just US$2bn (to US$48bn). As a stand-alone that is negative for the long end. But it’s the new December projections that has the market excited, as both 10yr and 30yr issuance is projected to fall by US$3bn (to US$37bn and US$21bn, respectively). In contrast, 2yr, 3yr and 5yr issuance volumes are to increase by US$8bn. So the issuance pressure morphs more towards shorter maturities and away from longer maturities as we head through the fourth quarter. Yields are down. The 10yr now at just under 4.8%. It has not materially broken any trends though. The big bond market story from the FOMC outcome is an underlying continuation theme. Higher real rates have been a feature since the last FOMC meeting, and the one before. And the Fed knows that this has a clear tightening effect. It’s a rise in market rates that cannot be easily diversified away by liability managers that need to re-finance in the coming few quarters. The Fed knows that both floating rate debt and all types of re-financings will amplify pain as we progress forward. Given that, it can let the debt markets do the last of the pain infliction for them. The rise in real yields has helped to push the curve steeper, and the 5/10yr has now joined the 10/30yr with a positive upward sloping curve. Only the 2/5yr spread remains inverted. This overall look does suggest the bond market is positioning for a turn in market rates ahead. The big move will come when the 2yr starts to anticipate cuts. We are not there quite yet; hence the 2/5yr inversion hold-out. That all being said, there is enough from the Fed today for the market to use the opportunity to test lower in yields. We still think we need to see the payrolls report first. If that is close to consensus then there is likely not enough to make the break materially lower. It is true that Powell has pointed to higher long rates as a pressure point. But does not have to mean that upward pressure on long rates suddenly goes away. There is still a path back up to 5% if the market decides not to use the double positive today of lower long-end supply (in relative terms) and a Fed that is pointing at long yields as something to get concerned by. We still feel that pressure for higher real rates remains a feature, despite the easing off on longer tenor issuance pressure. We need to see the economy really lurch lower, in particular on the labour market, before the bond bulls take over. The Fed is not quite pointing towards this just yet either.   FX: Too little to reverse the dollar momentum Markets perceived today’s Fed announcement and press conference as moderately dovish, and the drop in Treasury yields would – in theory – point to a softer dollar. The 2-year EUR-USD swap rate differential is around 8bp tighter than pre-meeting, but remains considerably wide at -128bp. As shown in the chart below, such a differential is consistent with EUR/USD trading around 1.05-1.06 and, despite the acknowledgement that financial conditions have tightened, there weren’t enough dovish elements to trigger a material dollar correction.   EUR/USD and 2Y swap rate gap     Looking ahead, we remain of the view that the dollar’s direction will be set by US data as the Fed’s reiteration of its higher for longer approach and threat of another hike still keep the big bulk of the bullish dollar narrative alive. Barring a negative turn in US activity data, our 1.06 EUR/USD year-end target remains appropriate. There are probably more downside risks in the month of November, although in December the dollar has negative seasonality.

Rates Spark: US jobs data can be key It has been a big move lower in long-end rates over the past days, and today's US jobs data will be key in determining whether it has further to run. Notably, however, the front end has started to turn higher again. The Fed, having tied itself to long-end rates to a degree, may start pushing back against easing financial conditions.   The rally in long-end rates extended with curve flattening accelerating Overall, we have now seen a drop of close to 30bp in 10Y and longer yields over just two sessions – the 10Y is now at 4.66% and 30Y at 4.80%. As seen in the move higher before, it was also in large part a move in the real interest rate component in this leg lower. The 2s10s curve has reflattened by a substantial 18bp with the larger part of that dynamic actually coming yesterday. The lower-than-feared long-end supply fuelled by the US Treasury has helped, as has weaker macro data. And certainly, there was evidence of value hunters out there getting in at 'high' yield levels. Markets will now be taking a close look at today’s US jobs data to determine whether yields have further room to fall. Yesterday’s US labour market indicators have already helped provide 10Y yields the final nudge below 4.7%. The initial jobless claims ticked a little higher to 217k from 212k and more importantly continuing claims rose to 1815k. That latter figure has been rising over the past month and a half. While the rate of layoffs might still be considered low, it suggests that if you do lose your job it is becoming more difficult to find a new one.   The Fed may push back agains financial conditions easing again The rally on long-end rates over the past sessions also highlights another conundrum for the Fed. By essentially referencing the higher longer rates as reason to withhold further tightening it has created an awkward interdependency with the market. The Fed said it needed to see persistence in the changes to broader financial conditions for it to have implications for the policy path. While there are good reasons to assume that further tightening is off the table, the prospect of a larger rally in rates bringing them back again potentially limits the downside at the onset. The caveat is that this may only work to the degree that long-end rates are actually driven by policy expectations. Front-end rates certainly are and pushed actually higher yesterday with the 2Y yield close to 5% again. That in mind, the Fed’s interdependency with the market is adding to the re-flattening dynamic of the curve.   As the-long end rally extended, front-end resistence accelerated the flattening   Today's events and market view We have doubts that this is the end of rises in long-dated market rates. For that to happen we would need to see material labour market weakness, putting today's job market report squarely in the spotlight. The consensus is looking for a 180k rise in non-farm payrolls, with forecasts ranging from 125k to 235k. It will be a slowdown from September’s bumper figure of 336k, but even the consensus figure would still be relatively robust – cooling, but making it hard to argue that the labour market is really troubled yet. As for supply as a driver, the market is effectively still facing higher issuance at upcoming Treasury auctions, and we are not even speaking of unresolved long-term debt trajectory concerns. As for the weaker ISM manufacturing that had helped drive the rally, it had been in contractionary territory since last October. The more relevant indicator should be today’s non-manufacturing ISM. And with regards to the Fed, the speaker schedule is looking busier again after the meeting and the drop in longer rates may get some pushback.

Rates Spark: A 30yr headache The tail on the US 30yr auction was big. Effectively a 5bp concession to secondary was required to get the paper away. Hence the ratchet higher in yields. The front end too is feeling renewed pressure from the Fed. No easy ride here for players tempted to trade this from the long side post payrolls. We maintain a non-conviction preference to go the other way.   Difficult to ignore a 5bp tail at auction The US 30yr auction tailed dramatically – by over 5bp. The tail on the 10yr on the previous day was largely ignored, at least initially. But a tail this big could not be. Still the reaction was quite spectacular. Things, however, calmed after the impact break back above 4.8%. But still, we now have the 30yr yield in the 4.75% area and the 10yr in the 4.65% area, with the latter well back above the 4.5% level that has acted as a bit of a floor since hitting it after payrolls. In fact, we are now back in the area we were at just before last Friday’s payrolls report.   Excess liquidity falling, but value in the 2yr now at above 5% And as expected, no surprises from Powell at the IMF conference. It’s clear that the Federal Reserve wants to maintain a tightening impulse. This makes sense, as any hint of neutrality would hasten a market dash to discount rate cuts. There is also the risk that the Fed is not just saying stuff, but could in fact hike again if needed. Next week’s CPI report is likely to show that headline inflation is homing in on 3%, but the issue is core which will still be in the 4% area, as is core PCE. With inflation here, the Fed is nowhere near caving into the rate hike talk. The 2yr US yield popped back above 5% following Powell's speech. But if there was an area of the curve where we feel relatively comfortable to be long it’s a 5% handle on the 2yr. The funds rate today is 5.33%, only slightly above. And even if there were one more hike, the bigger moves would be to the downside on a one year forward basis. If the Fed gets to 3% by mid-2025 (our view), then the breakeven US 2yr yield is 4.5%. Given that, the 5% handle on the 2yr looks generous, and incorporates much less interest rate risk than longs right out the yield curve. On the front end, we also saw an historic day of sorts, as the cash going back to the Federal Reserve on the reverse repo facility dropped below US$1trn. That is still a large volume of excess liquidity in the system, but it has come down from the US$2.25trn area since the summer is a precipitous manner. A lot of this reflects the build in the Treasury cash balance, from close to zero in the summer before the debt ceiling was lifted, to near US$800bn now. Going forward, the bulk of the fall in usage of the reverse repo facility will come from ongoing quantitative tightening.   The deterioration in Treasuries liquidity is worth noting and it is worrying Even though we still have ample liquidity conditions based off these measures, and some US$3.3trn of bank reserves, there has been a material deterioration in liquidity in US Treasuries. The Bloomberg measure of Treasury market liquidity based off persistent dislocations from fair value is at an extreme right now. It is even more extreme than seen during the pandemic. The big movements seen in long dated yields is reflective of this too, where volumes have been less impressive than the big price movements might suggest. It is tough to stay in the trades in long dates in these circumstances. Given that the 4.5% level has not been crashed though, we maintain a preference for a heavy market here where yields can test the upside. Part of the reasoning here is a lack of rationale to capitulate lower in long dated yields. That will come, but it’s not yet a conviction bet.   The day ahead The day ahead is light for data. The main focus ahead of the weekend will be on the University of Michigan readings. Expectations are well below average, and are expected to remain so. Inflation expectations are expected to remain on the high side though, with the 1yr inflation expectation at 4% and the 5-10yr expectation at 3%. There are a few Fed speakers too to be aware of, with Logan, Bostic and Daly due to speak. And in the eurozone we expect to hear from Lagarde and Nagel. We are not expecting a lot of fireworks from this lot at this juncture. The (net) hawkish pressure will be sustained.

FX Daily: Bond bears give new energy to the dollar A very soft 30-year Treasury auction and hawkish comments by Powell triggered a rebound in US yields and the dollar yesterday. Dynamics in the rates market will remain key while awaiting market-moving US data. In the UK, growth numbers in line with expectations, while in Norway, inflation surprised to the upside. USD: Auction and Powell trigger dollar rebound The dollar chased the spike in US yields yesterday following a big tailing in the 30-year Treasury auction and hawkish comments by Fed Chair Jerome Powell. Speaking at the IMF conference, Powell warned against reading too much into the softer inflation figures and cautioned that the inflation battle remains long, with another hike still possible. If we look at the Fed Funds future curve, it is clear that markets remain highly doubtful another hike will be delivered at all, but Powell’s remarks probably represent the culmination of a pushback against the recent dovish repricing. Remember that in last week’s FOMC announcement, the admission that financial conditions had tightened came with the caveat that the impact on the economy and inflation would have depended on how long rates would have been kept elevated. The hawkish rhetoric pushed by Powell suggests that the Fed still prefers higher Treasury yields doing the tightening rather than hiking again, and that is exactly what markets are interpreting. The soft auction for long-dated Treasuries also signals the post-NFP correction in rates may well have been overdone and could set a new floor for yields unless data point to a worsening US outlook. Today’s highlights in the US calendar are the University of Michigan surveys. Particular focus will be on the 1-year inflation gauge, which is expected to fall from 4.2% to 4.0%. On the Fed side, we’ll hear from Lorie Logan, Raphael Bostic and Mary Daly. Dynamics across the US yield curve will have a big say in whether the dollar can hold on to its new gains. Anyway, we had called for a recovery in DXY to 106.00 as the Fed would have likely pushed back against the dovish repricing. The rebound in yields should put a floor under the dollar, but we suspect some reassurances from the data side will be needed for another big jump in the greenback.

All eyes on US inflation and the government's funding deadline  By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank   What everyone – most investors, every household and every politician want to see and to sense right now is the end of the global monetary policy tightening cycle, and the beginning of the end starts mostly with the Federal Reserve (Fed).   Until the beginning of this month, we have seen a pricing that reflected the market's belief that the Fed is going to keep the rates high for long because the world is now braced for an extended period of high inflation. And the rapid rise in the US long term yields because of this very belief that the Fed will keep rates high for long helped the Fed keep its rates steady, at least at the latest meetings. The US 10-year yields spiked above the 5% mark in the second half of October, stagnated close to this peak for a week.   Then, a sufficiently soft set of jobs data from the US at the start of the month, combined with a record but lower-than-expected Treasury borrowing plans slowed down the sharp selloff in US Treasuries and reversed market sentiment. Investors, since the beginning of this month, began flocking back into the US long-term papers. The US 10-year yield tipped a toe below the 4.50% level, this time. We are talking about a plunge of more than 50bp for the 10-year paper in about two weeks.   And finally, last week, two bad 10- and 30-year bond auctions in the US, and Fed Chair Powell's warning that the Fed could opt for more rate hikes if needed, brought bond investors back to earth. And the 10-year yield rebounded from a dip. This is where we are right now – a period of heavy treasury selloff, followed by significant inflows, and uncertainty.   The uncertainty regarding when the Fed will be done hiking the rates is killing everyone, but even the Fed itself doesn't know when tightening will/should end. It will depend on crucial economic data, like inflation, jobs, and growth figures. The US jobs data is giving signs that the US labour market has started loosening. The US growth numbers are off the chart, but spending isn't necessarily sitting on solid ground, as the US credit card loans go from peak to peak and the credit card delinquencies have taken a lift. The delinquency rate is above the pre-pandemic levels, and just around the post-GFC levels – this means that the Americans spend on debt that they can't pay back anymore. And the US government debt is – as you know - growing exponentially, and Americans pay significantly higher interest on their debt because the rates went from near zero to above 5% in less than two years.  But uncertainty regarding the US debt does not mean that the US Treasuries will fall off grace, because there is nothing comparable to the US Treasuries that could replace US treasuries in a portfolio for low-risk allocations.   Volatility in this space is however unavoidable. This week, we will plunge back into the US political saga, as the government short-term funding deadline is due 17th of November and not much progress has been made to seal a fresh deal. And remember this, the last time the US politicians agreed on a short-term relief package, Joe Biden was forced to leave the funding for Ukraine outside of it. Since then, a new war in Gaza popped up, and the US is now expected to bring financial contribution there, as well.   We could see the US long-term yields recover from the past weeks' decline. Depending on the new funding resolution – or the lack thereof – we could see the US 10-year yield return above 4.80%.   Happily, slower inflows into US treasuries will be a relief for the Fed, which needs the yields to remain high enough to restrict the financial conditions without the need for more action. But the US political shenanigans are only one part of the equation. The other part is...economic data.   The all-important inflation data due Tuesday is going to impact the inflow/outflow dynamics in US Treasuries before the worries grow into the Friday funding deadline. A sufficiently soft inflation read should keep bond traders in appetite for further purchases and mask a part of the political worries, while disappointment could keep buyers on the sidelines and amplify a potential political-led selloff. The good news is that the US headline inflation is expected to have eased to 3.3% in October, from 3.7% printed a month earlier. Core inflation is seen steady around the 4.1% level. The bad news is, the expectation is soft and could be hard to beat.   The US dollar sees resistance at around the 50-DMA, the US stocks continue to cheer the latest pullback in the US yields. The S&P500 closed last week with a beautiful rally, that led the index to above its 100-DMA for the weekly close. The big tech remains the driver of the S&P500 gains as Microsoft hit a fresh high on Friday and Nvidia remained bid a few points below its ATH on news that Chinese AI startup bought enough Nvidia chips before the US exports curbs kicked in. This week, US big retailers will announce their Q3 results and will give a hint on the US consumer trends, health and expectations. Earnings could be mixed but the overall outlook will likely be morose.   

Rates Spark: Shifting the rate cycle discount How convinced are we that the Fed has peaked? You can never be 100% sure on this, but the odds firmly favour the view that they’re done. That places rate cutting on the radar. Ahead of that, market rates tend to ease lower.   Have market rates peaked in the United States? Most probably yes The US 10yr has gapped below 4.5% in the wake of the CPI report – immediate impact effect. It did feel like Treasuries were waiting for this report before making any conclusive subsequent move having had a look below 4.5% twice and each time finding an excuse (good ones though) to get back above. Although the headline inflation rate is now 3.2%, the caveat is that core is still at 4% (even if lower than the 4.1% expected). But the path is positive, and that’s what the market rates are extrapolating. It is still not clear that market rates should capitulate lower from here though. Tuesday’s CPI report was great. But the absolute numbers mean there is still some inflation reduction work to get done. There will be an interesting supply test next week from the 20yr auction, which will be watched following the badly tailed 30yr one last week (the main reason we gapped higher again in yields). On the front end, the 2yr is back in the 4.85% area, having been above 5%. This is an easier sell. A big move lower is likely here. It’s only a matter of when – typically it’s about 3 months before an actual cut. Not quite at that point, but it will be there as a theme over the turn of the year. Breakeven inflation has also moved lower post the number. But real yields are lower by more – by over 20bp in the 10yr (now 2.2%). Real yields are still elevated though, and reflective of macro resilience and the fiscal deficit. That’s a resistance that can remain an issue for longer tenor market rates. Ongoing dis-inversion and a steeper curve ahead.   Today's events and market view The CPI data gave the market the green light to drop the 10Y US yield back to just below 4.5%. EUR rates were pulled lower alongside, bull flattening with the 10Y Bund yield touching 2.6%. This level held twice last week, having marked the lowest yield since mid September. Today’s calendar features more data that could feed the bullish sentiment. We will get the US producer prices and  we will likely also see softer retail sales data, where gasoline prices will have depressed values of sales. But as our economists point out, vehicle sales were down on the month and that credit card spending has been subdued, also pointing to a soft spending number. In the eurozone, markets will be looking at industrial production data, pointing to a worsening situation in the sector. With a view to the risk of a government shutdown, there are signs that the Speaker's interim plan that continues government funding at current levels until early next year has some support among Democrats. In primary government bond markets Germany will tap two 30y bonds for €2bn in total.

The Fed is done and market rates have peaked – so what now? Market rates have likely peaked. The 10yr hit 5% and the 2yr got to 5.25% in the past month or so. A move back toward 5% is not improbable for the 10yr, but it's more likely that we've morphed into a structural decline in market rates, and a steeper curve. Most of the time a peak for the Fed correlates with a good time to get long, or at least to average in as rates rise.   Most of the time a peak for the Fed correlates with a subsequent tendency for market rates to fall – it tends to be a good time to get long Have market rates peaked in the United States? Most probably yes. The Federal Reserve is likely done too. If true, the Fed has in fact been done since 26 July this year, and has been at a peak rate for almost four months now. When the Fed peaks, it’s a key moment for markets. Most of the time a peak for the Fed correlates with a subsequent tendency for market rates to fall – it tends to be a good time to get long. Getting long can take on many guises. For asset managers is means buying longer dated higher quality securities, even into an inverted curve, as this means locking in existing running yield for longer. For liability managers, getting long means setting fixed rate receivers, which is effectively like a funded long in a bond. It’s also code for swapping to floating, where exposure to falling official rates is sought. It's no surprise that over the long term being exposed to floating rates is the cheapest form of funding. Despite the volatility that is implied, an average upward sloping term structure tends to result in a lower cost of funding. In fact, there is no example of a 10yr fixed rate receiver resulting in negative carry at any time over the past number of decades (as 10 years is long enough for floating rates to on average be lower than the 10yr rate that has been locked in). Moreover, when the Federal Reserve is at a peak, realised carry on fixed rate receivers tends to be maximised (graph below). It’s the opposite when we are at the bottom of the rate cycle, as this is the optimal time to set a swap to a fixed (rate payer). Similarly, for the asset manager, this is the best time to be short on interest rate exposure, as the path ahead then is for the Fed to be hiking rates, and pushing market rates higher. That’s for another day. Today we’re concerned with the peak in the cycle.   Realised carry from setting fixed rate receivers (5yr, 7yr and 10yr compared)   Getting long the bond market comes in many guises, but now is the time How convinced are we that the Fed has peaked? You can never be 100% sure on this, but the odds firmly favour the view that they’re done. Latest headline consumer price inflation has fallen to 3.2% and the latest 3mth annualised reading for the core personal consumer expenditure deflator is at 2.5%. That’s bang on the 20yr average for US inflation. It has to be said that the US has managed a remarkable easing in inflation, despite the ongoing firmness in the labour market. But that labour market firmness won’t last. Every day the effective funds rate remains at 5.3% the pressure builds on e.g. the typical credit card debt holder that finds themselves paying rates in excess of 20%. All debt holder subject to re-sets at higher rates face similar issues, ones that won’t go away as the Fed holds. Also, falling inflation does not mean falling aggregate prices, so living standard pressures from high prices remain. The transmission mechanism to the economy is through higher delinquencies, and a wider lower spending link in consequence. The Federal Reserve does not need to hike rates further in order to sustain the pressure already beginning to be felt by the economy. As these pressures build, concern morphs away from inflation and towards sub-trend growth, and possibly recession. That places rate cutting on the radar. Ahead of that, market rates tend to ease lower. And once we are about three months ahead of an actual cut, the 2yr yield will gap lower – it can move lower by 100bp in a matter of days, and keeps going. The engine that drives this is the Fed cutting from 5.5% currently, to (we think) 3% by mid-2025 (starting by mid-2024). Market rates anticipate a lot of this ahead of time. The anticipatory move lower on the front end is where value comes from exposure to paying floating rates for liability managers. And for asset managers, that means lower funding costs, and moreover, downward pressure on longer tenor rates, that are pulled lower by shorter tenor ones. If that all plays out, then being long is the way to go in the coming few months. A mini back-up in market rates is far from improbable, as the deficit pressure has not gone away and the economy has not exactly imploded. We'd use any such back-up as an opportunity to average in, adding to interest rate exposure for asset managers and to floating rate liabilities for liability managers

On a slippery floor By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank   While the US economy has been surprisingly resilient this year to the Federal Reserve's (Fed) aggressive monetary tightening, we cannot say that we have a similar soothing picture in Europe. The energy crisis, that followed the pandemic, has been hard on Germany. The country needs money when money becomes rare and expensive. Germany decided to suspend the debt limit for the 4th consecutive year – signaling that borrowing in Europe will continue to increase, and the new debt that the Europeans will take on their shoulders will cost significantly higher than a few years ago.   German bonds fell yesterday on news of yet another suspension of the debt limit. The 10-year German yield advanced to 2.60%, Italy's 10-year yield jumped to 4.40%, the Italian – German yield spread rebounded this week from the lowest levels since September, and the widening yield spread between core and periphery could become a limiting factor for euro appetite at a time traders should decide whether the EURUSD should appreciate above the 1.10 psychological mark.   As per the European Central Bank (ECB) expectations, the European officials do their best to tame the rate cut expectations in the Eurozone. Belgian central bank governor Pierre Wunsch said yesterday that the ECB won't cut the rates as long as wages growth remains elevated, while the German central bank head Joachim Nagel said that cutting rates too early would be a mistake. A mistake? Maybe. Yet, economic data comes as further evidence that the European economies are not going toward sunny days. Released yesterday, the European PMI figures came in slightly better than expected, but the reading was below 50 for the 6th consecutive month, meaning that activity in the Eurozone contracted for the 6th consecutive month. The Eurozone GDP fell below 0 at the latest reading, while in comparison, the US GDP grew nearly 5%. This is to say that, based on the current data, the Fed has a greater margin for keeping rates steady than their European counterparts. It at least has better credibility. And the Fed's bigger hawkish margin compared to the ECB should keep the euro appetite limited against the US dollar following the rally since the beginning of October.   In the US, despite warnings that the falling US long-term yields will, at some point, trigger a hawkish reaction from the Fed and eventually reverse, the Fed doves remain in charge of the market. The US dollar index struggles to gain traction above the 200-DMA.   The USDJPY remains offered near the 50-DMA after the Japanese inflation advanced to a 3-month high in October (rose to 3.3% level from 3% printed a month earlier). Normally, it would've boosted bets of Bank of Japan (BoJ) normalization, but the BoJ should first awaken from its coma.  In energy, US crude trades near $75/76 region. Downside risks prevail due to speculation that the delayed OPEC meeting could result in Saudi Arabia not doubling its solo production cuts. There is even a slim possibility that they eventually reverse them.   I am wondering if this week's drama is not staged amid poor buying following the news that Saudi would doble its cuts, to cast shadow in Saudi's intention to defend oil prices, to bring attention to OPEC and to Saudi which finally would go ahead and double its production cuts hoping that the market reaction would be stronger than if they had announced the same outcome this weekend. In all cases, deteriorating growth prospects will likely limit the upside potential in oil prices in the medium run. The short run will certainly see more volatility.    

Rates Spark: Pressure at the extremities The fair value number for the US 10yr yield is 4%, but we really need to see Friday's payrolls number first. The bond market is screaming at us that it'll be weak. But unless validated, the rally seen of late is vulnerable. Also be aware of front end pressure, although this was calmer yesterday.   Resumed inversion points to overshoot risk in the 10yr yield An interesting aspect of the price action in the past couple of days has been the resumed inversion of the US curve. The front end is participating in the falling yields trend, but the 10yr benchmark is leading it. That can reflect an overshoot tendency in the 10yr. It is true that the JOLTS data showed a surprise drop in job openings, but that should have been just as capable of sparking a larger front end move, helping to dis-invert the curve. At the same time, such price action is consistent with a 2yr yield that does not yet see a rate cut as a front and centre event. Typically, the 2yr really gaps lower about three months before an actual cut. But in the meantime, it should be capable of keeping better pace with the falls in yield being seen in the 10yr. While we are of the opinion that 4% is the structural fair value number for the 10yr (on the assumption that the funds rate targets 3% as the next low), we also feel that this market needs a weak payrolls number on Friday to validate the move seen in the 10yr yield from 5% all to way down to sub-4.2% in a matter of weeks. The fact remains that we have not seen either a labour market recession or a sub-trend jobs growth experience. At least not yet. The market is trading as if the 190k consensus expectation is wrong for Friday and that we’re going to get something considerably weaker. The JOLTS data supports this – as does the latest Fed Beige book. But we do need to see that report before we could even consider hitting 4% on the 10yr.   Repo pressures ease, but still some cross-winds to monitor on money markets At the other extreme of the curve, the elevation in repo rates seen at the end of November that had extended into Monday of this week had begun to ease back through Tuesday. The issue here is ultra front end market rates had come under upward pressure. Extra bills issuance has been a factor, as this has both taken liquidity from the system and placed upward pressure on bills rates generally. Repo is a function of the relatives between available collateral and available liquidity and at month-end, liquidity was tied up, and that pressured repo higher. The resumed build in volumes going back to the Fed on the reverse repo facility on Tuesday proves a reversion towards more normal conditions. That said, SOFR remains elevated, and that will contribute to balances falling in the Fed’s reverse repo facility as we progress through the coming weeks. If the market is showing a better rate than the 5.3% overnight at the Fed, that should take cash from the reverse repo facility. Interestingly there was a surprise jump in usage of the standing repo facility. Not large, but it shows that in some quarters there is at least some demand for liquidity. A bit early for this to become the dominant issue, but worth monitoring all the same.   Today's events and market view The JOLTS data highlighted the markets' sensitivity to any indications of a cooling US labour market. Ahead of Friday's payrolls report, markets will eye the ADP estimate. Given its poor track record of forecasting the official data, it is likely to take a larger surprise to move valuations – the consensus is looking for a 130k reading today after 113k last month. Other data and events to watch are the US trade data and, up north, the rate decision by the Bank of Canada. On this side of the Atlantic, we will get eurozone retail sales and, in the UK, the Bank of England financial stability report. In government bond primary markets, Italy is conducting an exchange auction. The UK sells £3bn in 10Y green gilts. The main focus over the coming days and weeks will be on governments’ announcements regarding their issuance plans for next year.

Rates Spark: A bond market looking for validation Payrolls day is usually pivotal. This one more than most, as the US 10yr has fallen sharply from 5% down towards 4% without material evidence of any labour market recession. We don't have to have one, of course, as lower yields can also be validated by lower inflation expectations. But in the end, it probably does have to happen, or else bonds have issues ... The key event for the day is the US jobs report, the nonfarm payrolls Source:   Today's payrolls report will set the scene for the rest of 2023 It’s payrolls day! And it’s a key one. The US 10yr has moved sharply from 5% down to approaching 4%. It really needs some validation of that move from today’s report. Or to reverse engineer this, the Treasury market is telling us the number will be weak. But what is weak? The key reference is 150k. That’s the replacement rate. Average payrolls in the past few decades have been 130k per month. Anything below these numbers would be “weak”, as it would begin to signal a growth recession. This month’s number is bolstered by returning strike workers so that the consensus of 190k actually translates to something close to 150k – bang on the crossover point. Whatever happens, it will set the scene for the week ahead, one that kicks off with supply, featuring the 30yr auction which has had a habit of tailing. Any kind of payrolls “strength” would have to be a problem for this bullish bond market.   And then we have the Fed next week. Payrolls are likely more important We also have the Fed next week. There may be some interest in the press on money market conditions following the spikes seen in repo around month end and reverberating into the early part of December. This comes against a backdrop where banks' reserves are ample, in the US$3.3tr area. The last time the Fed engaged in quantitative tightening, bank reserves bottomed at a little under US$1.5tr and there was a material effect felt on the money markets. It’s unlikely that we'll get anywhere near that this time around. Bank reserves will almost certainly get below US$3tr and possibly down to US$2.5trn. The Fed will want to get liquidity into better balance as a first port of call, but beyond that, it won’t want to over-tighten liquidity conditions. Taking this into account, QT is likely to end around the end of 2024. In the meantime, the clearest manifestation of quantitative tightening is to be seen in falling liquidity volumes going back to the Fed on the overnight reverse repo facility. This is now at US$825bn, but is set to hit zero in the second half of 2024. Whether Chair Powell gets drawn into this will likely be down to whether the press wants him to - they will probably have to ask the questions(s). In terms of expectations for market movements, we doubt there will be much from the FOMC alone. If, as we expect, the Fed sticks to the hawkish tilt, and does not give the market too much to get excited about, then expect minimal impact. As it is, the structure of the curve, as telegraphed by the richness of the 5yr on the curve, is telling us that a rate cut is not yet in the 6-month countdown window. That will slowly change, and we’ll morph towards a point where we are three months out from a cut and the 2yr yield really collapses lower. It's unlikely the Fed will change that at this final meeting of 2023, though, and they won’t want to. Expect much more reaction from today’s payrolls report Today's events and market view The key event for the day is the US jobs report. The consensus for the change in non-farm payrolls has slipped somewhat to 183k, which compares to the 150k reported last month. The unemployment rate is seen staying at 3.9%. The other release to watch today is the University of Michigan consumer sentiment survey. It is seen improving marginally, while the inflation survey is expected to ease to 4.3% on the 1Y horizon and 3.1% on the 5-10Y. There is not much on the eurozone calendar, but the ECB will reveal how much of their outstanding TLTROs banks choose to repay ahead of time at the end of this month on top of the €37bn that will mature.

CEE: Fair level reached before next move Yesterday's data published in Poland was fairly mixed, indicating cautious signs of recovery in industry and construction but weaker growth in retail sales. The general economy gained momentum in the fourth quarter of last year but the pace slowed after the third quarter. December is again hopeful that a recovery is coming. Today's calendar is essentially empty except for Hungarian wage data. It gets more interesting in the bond space. In Poland, the first auction will take place today after the recent sell-off and political tensions. At the same time we saw a hawkish turn from the National Bank of Poland. So today's auction will test where demand is after recent events. The FX market opened the week in CEE in line with our expectations yesterday. PLN managed to stabilise around 4.360 per euro and for now we don't see too much bias either way until we see more progress on the political side. EUR/CZK remains in the 24.700-800 range where it is likely to remain in the days ahead, unless the CNB steps in with bolder statements than we have seen so far. EUR/HUF has moved up into our 383-384 range and given the rate pricing we think this will be the level ahead of the National Bank of Hungary's meeting next week.

Czech National Bank Preview: Time to catch up We expect the pace of cutting to accelerate to 50bp, which will push the CNB key rate to 6.25%. The main reasons will be low inflation in the central bank's new forecast, which should allow for more cutting in the future. For year-end, we see the rate at 4.00% but the risk here is clearly downwards.   Optimistic forecasts could speed up the cutting pace to 50bp The Czech National Bank will meet on Thursday next week and will present its first forecast published this year. We are going into the meeting expecting an acceleration in the cutting pace from 25bp in December to 50bp, which would mean a cut from the current 6.75% to 6.25%. This means a revision in our forecast, which previously saw an acceleration taking place in March. Still, it's certain to be a close call given the cautious approach of the board – and that could bring a 25bp cut.   The board will have a new central bank forecast, which is likely to be a key factor in decision-making. Here we see the need for revision in a few places, but overall everything points in a dovish direction. On the global side, compared to the November forecast, we expect the CNB to revise down both GDP growth, rates and oil prices. On the domestic side, inflation has surprised downwards only slightly in the past three months for both headline and core inflation. Still, we expect some downward profile shift due to a better outlook for food, energy and oil prices. As for GDP, the CNB was the most pessimistic forecaster in the market in November and the incoming data was rather mixed in this regard, so we expect only modest changes here. The CZK was 0.35% stronger than the central bank's expectations in the fourth quarter of last year. On the other hand, it was slightly weaker in January. Overall, we do not see any significant impact on the new forecast here, but the lower EURIBOR profile after the revision may indicate a stronger CZK in the new forecast, or allow for faster rate cuts in the CNB model. The November forecast indicated roughly a 50bp cut in the fourth quarter last year and reaching 3.50% by the end of this year, delivering a total 350bp of rate cuts. As we know, the CNB delivered only 25bp last year, which will need to be reflected in the new forecast. Overall, we expect a slightly steeper rate path again with a 3.00% level at the end of 2025, which should have a dovish outcome for the market in our view. As always these days, we can also expect several alternative scenarios, one of which will be the board's preferred scenario, showing a slightly slower rate cuts profile than the baseline.   Inflation nowcast will be key to the decision We see from public statements that the dovish wing of the board (Frait, Holub) will push for a faster pace of rate cuts given inflation numbers indicating a quick return to the 2% inflation target this year and will be open to more than 50bp of rate cuts. For the rest of the board, we think the inflation indication for January and beyond in the central bank's new forecast is key. We are currently expecting 2.7% for January headline inflation, with room for it to come in lower if the anecdotal evidence of January's repricing is confirmed. This, in our view, will give the rest of the board the confidence to accelerate the pace of cutting as early as this meeting.   4% at the end of the year or lower depending on core inflation Looking forward, we believe the favourable forecast for the coming months will allow the 50bp pace to continue. Here, our forecast remains unchanged and we think core inflation will still prevent the board from going faster later. We therefore still assume a 4% key rate at the end of this year. But if core inflation continues to surprise to the downside, we find it easy to imagine lower levels here.     What to expect in FX and rates markets The CZK has weakened in recent days following comments made by Deputy Governor Jan Frait and touched 24.90 EUR/CZK, which is basically the weakest level since early 2022. If the CNB delivers a 50bp rate cut, it's obviously negative news for the CZK. But on the other hand, we believe that the market positioning is already heavy short and rates are already pricing in the vast majority of CNB rate cuts. That's why we see the cap at 25.20 EUR/CZK. A minor cut, however, could bring a temporary strengthening towards 24.70 given heavy dovish expectations. In our base case scenario, we think that after the 50bp rate cut and January inflation, the market should have hit the limit of what can be priced in and the CZK should start appreciating again later this year thanks to the economic recovery, good current account results and falling EUR rates improving the interest rate differential. The rates market fully priced in a 50bp move recently and expects another 50bp move for the next meeting, which is close to our forecast. However, the terminal rate is already priced in at 3% at the end of this year, which we don't have on paper until next year – but we still see this as a possible scenario if inflation remains under control. If we do see the CNB's forecast, the market can easily get excited for a lower terminal rate and overshoot market pricing. Therefore, we expect the combination of the 50bp cut and the dovish forecast to push market rates further down, resulting in further steepening of the curve. In the bond space, we maintain our positive view here going forward. Czech government bond supply has fallen significantly as we expected and, combined with the inflation profile and central bank cutting rates, offers a perfect combination in the CEE region. Here, we continue to prefer belly curves and see more steepening.