Comment on Yesterday’s FI Sell-off

Comment on Yesterday’s FI Sell-off

Today’s key points

  • We argue that the combination of a weakening business cycle and central banks sticking to a dovish rhetoric should cap the upside for yields in Q2.
  • The risk factor for global FI markets is further spikes in commodity prices, especially if the Trump administration engages in a tougher stance towards Iran.

Global yields have seen upward pressure over the past 24 hours. In our view, there were no obvious drivers for the sell-off but a combination of renewed focus on commodity prices and supply from France and Spain probably drew yields higher in the European market. The negative sentiment was carried over to the US, where 10Y US treasury yields rose 5bp to 2.92% and 2s10s and 5s30s steepened after flattening significantly over the past couple of weeks. 10Y US breakeven inflation expectations rose once again, underlining the impact of higher commodity prices.

However, we doubt we are in for a significant new jump in yields as in January and February, where 10Y Germany rose 35bp over six weeks.

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1. The business cycle is weakening

Yesterday, we published a research paper where we looked at the global business cycle. Research: Global business cycle moving lower.

Here, we argue that there are clear signs that the global business cycle peaked in early 2018. Furthermore, our MacroScope models point to a further deceleration over the coming quarters. Declining PMI levels across regions tend to cause some anxiety about the strength of the recovery and would normally put a cap on bond yields.

2. Central banks are not turning more hawkish in Q2

Hence, if global yields are to see further strong upward pressure, the driver needs to be a new spike in commodity prices or change in rhetoric from central banks. We doubt the latter will be the case if the global business cycle is weakening. In that respect, see ECB Preview – Not on Draghi’s watch from today, in which we forecast that the ECB will not hike before December 2019. Regarding central bank rhetoric, note also that BoE Governor Mark Carney struck a dovish tone in an interview last night, stating that a few rate hikes may be warranted over the next few years, thus essentially questioning whether a May hike is a done deal after all. Carney came after the close of the Gilt market and Gilts are higher this morning. We also expect a soft stance from the Riksbank next week, as we expect the Riksbank to postpone the first rate hike to 2019.

Commodity prices are the risk factor for global FI markets

In our view, the main risk factor for global FI markets here in Q2 is the global commodity market. The sanctions against Russia could still push some metal prices higher even after aluminium and nickel have jumped recently. In the oil market, it is noteworthy that the supply and demand balance has improved this year (lower stocks). However, especially oil prices could be pushed higher if the Trump administration decides to take a tougher stance on Iran. However, it would be a supply-driven oil price, which the ECB should be less eager to react on.

Bottom line: the risk of a more pronounced fixed income sell-off here in Q2 should be modest, in our view.

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