It was a bloodbath in the major equity market indices on Monday, with the worst single day losses seen this year. A growing narrative that growth in the US and other major economies may have already peaked, reinforced by Covid variant resurgence fears has knocked off roughly half a percentage point in 10-year Treasury yields from their spring interim highs, while reining in previous optimism in the equity market space that had lifted the indices to new records. German 10-year yields moved -12 bps deeper into inversion at -.42% on a week-over-week decline of -12 bps. Even 30-year yields now stand only a few basis points positive, as the whole German government curve threatens to fully-invert. The German DAX stock market index gave back about -650 points of its 2021 advance over the past week, retreating to current levels near 15130 as the brick wall of upside resistance in the 15800 to 16000 area held firm. In credit, 10-year investment grade spreads were seen only marginally wider near +90 bps on the week, holding still longer to the relatively tight 2021 range of approximately +80 bps on the downside and +95 bps on the upside. It continues to be a different story at the lower end of the credit spectrum however, with lower-rated 10-year BBs out another +18 bps on the week and +49 bps on the month to current levels of +100 and +292 bps respectively.
Thursday’s ECB policy meeting is now seen as more pivotal than it had been viewed before the recent release of the Bank’s latest 18-month strategy review. Historically, the ECB policy framework had been asymmetric in nature, with its mandated price “stability” defined in terms of inflation “below, but close to, 2 percent” over the medium term. With however the release of the ECB’s latest Strategic Review on July 8, the 2.0% target was redefined such that both positive and negative deviations were thereafter to be viewed “equally undesirable”. Like the US Fed then, the ECB was effectively giving itself the policy latitude to overshoot its target, or as suggested by Governing Council member Centeno last week “room for maneuver”.
While the Board agreed unanimously to change in principle the more symmetric approach to the 2.00% target, no formal agreement was reached on actual short term policy ramifications. Accordingly, Thursday’s policy meeting is no longer viewed as a summer month “non event”, with market observers on the lookout for changes in forward guidance, potential tweaks to or signals with respect to the PEPP asset purchase program going forward, signs of larger-than-normal divisiveness from within the ranks, and any material upsizing of the downside risks to the economy. It is noteworthy that the ECB is now incorporating the upward bias of housing costs into its measurement of inflation, and part of the target redefinition or tweaking would appear consistent with this.
The economic calendar out of Europe is quiet until Friday’s UK retail sales numbers, and a smattering of Markit PMI releases for the UK and mainland. Government supply is limited to the German 30-year auction on Wednesday.
The US government curve bull-flattened sharply this past week, with 10-year benchmark yields down a full -24 bps to current levels near 1.18%. As per 10-year TIPS market pricing, the move lower was led by a full -17 bps contraction in inflation-expectations proxy breakevens, versus the still-significant -7 bps paring in growth-sensitive real yields. Strategists continue to pare back their cycle peak calls for 10-year nominal yields, with the near-universal expectations for something at or north of 2.00% from only a few months’ back looking all the less-likely, certainly by year end. Credit spreads have started to move out more noticeably, partially however due to normal lagging of all-in corporate yields relative to more exaggerated moves in the government benchmarks. Over the past week, 10-year A, BBB, and BB-rated spreads are seen wider by +6, +5, and +28 bps to +89, +124, and +254 bps respectively, all now comfortably back of the cycle lows. Going forward, we believe the risk-return trade-off in the space remains unfavorable, as asset purchase tapering moves closer to reality. The rebound in the US dollar off May/early June interim lows continues, as the DXY dollar index sets its sights back on the late March 2021 year-to-date highs. The strength of the dollar kept the price of gold in check, even with other factors such as the drop in real bond yields more supportive. Oil has taken a tumble, moving down multiple big-figures on Monday back into the mid 60-dollar area, a full $10 or so lower versus recent cycle highs.
The economic calendar in the US is on the light side this week, with only housing starts & building permits on Tuesday, existing home sales on Thursday, and Markit manufacturing, services & composite PMIs on Friday. Supply features a $24 billion auction of 2-year Treasuries on Wednesday, and $16 billion in 10-year TIPS on Thursday. We also get next week’s supply announcement for 2s, 5s & 7s on Thursday. 27-28 The next major event in the US is the July meeting of the FOMC.
