Inflation remains front and center in the minds of global investors, so much so that many observers think the Bank of England may be poised to raise rates as early as the next MPC policy meeting on November 4, as the first major Central Bank to do so. That view was reinforced by the BOE’s Bailey who, while reiterating that inflation would likely prove temporary, added that surging energy prices would only sustain the upward pressure on inflation that much longer. Regardless, shorter term yields in the major markets are starting to play catchup with those in the mid and longer tenors as Central Bank tightening expectations move forward. In terms of US politics, we have an arbitrary October 31 Congressional deadline on infrastructure and reconciliation talks just around the bend with however no real signs of the progressive and conservation wings of the Democrat party itself bending on key issues. Realistically however, the next major test for markets comes in December with the expiry of the debt ceiling extension.
German government yields from the 7-year term and out moved lower this past week, led by a full -13 basis point decline in 30s. The curve pivoted flatter, with yields in the front end slightly higher over this time. 10-year nominal Bund yields fell -5 bps to -.14%, with the decline in real reals more than offsetting a +7 basis point increase in inflation breakevens, as per inflation linker market pricing. Over the past month and 3 months, inflation breakevens in Europe are up roughly +25 and +50 basis points respectively, pushing nominal yields back up towards the 2021 highs near -.08%. A move back into positive ground may still be in the cards for 2021, and much more certainly as a 2022 scenario. In credit, 10-year investment grade spreads held their ground in the mid 90s, while high yields tightened in a handful to 270 basis points. The DAX equity market came back strong this past week, rising more than +300 points towards the 15500 level with strong upside resistance in the 15800-16000 coming into view on the radar screen. The EUR inched back up to the 1.17 level off one-year lows just below.
The economic calendar in Europe this week features German PPI, the final EZ HICP inflation revision, and a full set of UK inflation releases on Wednesday, UK retail sales, and flash Markit PMI numbers for Germany, France, the EZ, and the UK on Friday. Government supply features 10-year offerings from both the UK and Germany on Wednesday, French 3s & 5s and Spanish 5s & 15s on Thursday. Several EU policymakers are scheduled to speak this week, including Elderson, Panetta, and Lane. The BOE’s Bailey speaks again on Tuesday.
US benchmark yields continued to move higher this past week, led by the belly of the curve. 10-year yields moved up +2 basis points against a +5 basis point increase in 5s. As per 10-year TIPS market pricing, inflation breakevens surged close to +8 bps on the week, more than offsetting a -6 basis point decline in 10-year real yields. Technically, upside yield support in the lower to mid 1.60s has held for now, with current levels back just inside the 1.60% level. The 2021 interim highs near 1.75% is expected to be at least challenged before the year is out, but a move to and through the key psychological 2.00% level is a more likely 2022 scenario. On the credit front, 10-year investment grade (IG) spreads narrowed back towards the 141 basis point level after resistance held at the top end of the close to 4 month range in the mid 140s. While tapering may already be priced into the credit space, the same optimism on the corporate earnings and cash flow generation front holding spreads in through the cycle may be beginning to wane, and as such we expect the lows for spreads may already be in. That said, no major move wider is expected just yet.
The economic calendar in the US got kick-started with Monday’s weaker-than-expected industrial and manufacturing production reports. For the balance of the week, we have housing starts/building permits on Tuesday, Philly Fed and existing home sales on Thursday, and Markit manufacturing, services & composite PMIs on Friday. The Fed releases its Beige Book on Wednesday. In terms of government supply this week, we have $24 billion in 20s for sale on Wednesday and $19 billion in 5-year TIPS on Thursday. As well, the supply announcement for next week’s 2s, 5s, 7s and 2-year FRN lineup is out this Thursday. It is again a busy week for Fedspeak, with voters Quarles, Waller, Daly, and Bostic all scheduled, some multiple times, as well as regional Fed Presidents Nashhari and Evans.