Rates Spark: A wedge between US and EUR rates

10Y UST yields have tested 4.36%, with the gap to Bunds opening further. The flash PMIs today shine a light on the contrasting macro backdrops. This is also reflected in real rates having been the driver of the US dynamic of the sell-off, while inflation expectations have played a greater role in EUR.

PMIs today shine a light on the contrasting macro backdrops

Upward pressure on rates remains persistent, keeping the 10Y UST yield above 4.3%. Yesterday we also saw the gap to 10Y Bunds widening somewhat, perhaps already in anticipation of the flash PMIs released today. They are set to highlight the contrasting macro backdrops between the US and the eurozone.

The eurozone PMIs are expected to show that the economy is increasingly feeling the weight of the European Central Bank’s tightened monetary policy. And that weakness could spread to the services sector, which has so far been relatively resilient while the reading for the manufacturing sector has been in contractionary territory for a year now.

A decomposition of the current upward leg in rates, i.e. the rise in 10Y nominal rates since around mid-July, highlights the different narratives underlying the moves in the US and Europe. While in the US the change was mainly driven by the real component, which also reflects expectations of growth, the more moderate rise in EUR rates was largely driven by the rise of the inflation component. That is also likely to cause some headaches at the ECB as it might call into question the bank’s inflation fighting credentials.

It has to be seen whether the PMIs today can extend that theme of divergence after the 10Y UST/Bund spread has now widened to 167bp already. There have also been other factors such as supply driving the wedge. For the US that theme had shifted back into focus with the Fitch downgrade of the US and increased issuance prospects, and crystallised in the weak 30Y auction two weeks ago. Tonight the sale of a new a 20Y bond still looms large. But also in the eurozone supply activities are starting to emerge from the summer lull.

Unlike in the US, the sell-off in EUR rates was driven more by inflation

Today's events and market view

The main event today is the publication of the preliminary PMIs for August. For the eurozone, the consensus expect the manufacturing PMI to remain unchanged in contractionary territory at 42.7. The services sector is seen further losing momentum with the PMI declining from 50.9 to 50.5. In The US we will also see new home sales data being released.

In European primary markets Germany will auction €3bn in 7Y Bunds. Finland will sell a new 5Y bond via syndication. Supranational, Sovereigns and Agencies will see the EFSF tapping a 3Y bond and sell €2bn in a  new 15Y bond. The main focus, as the US remains at the helm of the push higher in rates, will be the new US$16bn 20Y bond sold by the US Treasury tonight. Shortly before that the Treasury will also sell a 2Y floating rate note.