Treading the Yield Curve: Hawkish Signals and Rate Dynamics

A hawkish tone from the US CPI data and a hike from the ECB could give front end rates a larger lift this week, and provide the ingredients for a brief curve-flattening episode.

More broadly, however, we think the current environment remains marked by disinversion pressure on the US curve from the back end – which will also have spillover effects into Europe. The inverted curve makes long positions on the common notion that rates rally once the Fed delivers its final hike costly. Yes, that rates should rally it is what experience of the past tightening cycles back to 1994 has shown, but at the same time curves were also not as deeply inverted as they are now. As we have pointed out earlier, until activity actually stalls there is no imminent reason for the Fed to consider cuts - as that story persists, the floor for market rates is edging higher and becoming more structural at higher levels.

 

Today's events and market view

The BoJ’s hawkish tones over the weekend had given rates a nudge higher at the start of the week, putting 10Y yields in the US and Germany closer to the top of recent ranges. Supply activities have held rates in that elevated territory. Apart from that, the start of the week in rates was quiet, considering the relatively narrow trading ranges for the day.

Following the UK wage growth data there is little else on the data calendar for today with the key events only lined up for later this week. Nonetheless today’s US NFIB index can also give us insights into selling prices for instance and the ZEW is likely to highlight the subdued macro outlook for Germany – and the dilemma that the ECB Council will face when it has to arrive at a decision on Thursday.

With regards to primary markets the EU had mandated a new 7Y bond which should be today’s business. Germany sells €5.5bn in its 2Y benchmark while the Netherlands reopens a 3Y for up to €2.5bn. In the US we will see the reopening of the 10Y Treasury note for US$35bn.