Rates Spark: More Headwinds For Euro Bonds Next Week

By Benjamin Schroeder, Antoine Bouvet, Padhraic Garvey, CFA

The ECB’s pushback is becoming more explicit

US markets remain focussed on the looming recession, though data not being quite as bad yesterday allowed for a modest bounceback in rates. But it was a bigger bounce in Bund yields, where we witnessed more pushback from the ECB against the notion that its rate hikes could be downsized to 25bp starting in March. Going into the session, the ECB’s Klaas Knot put it very bluntly, saying that the ECB was planning on hiking by 50bp “multiple” times. President Lagarde, who had originally given out a series of 50bp hikes as a guidance at the last meeting, was less explicit in her remarks. She did make it clear, though, that inflation remained way too high and that the ECB would stay the course.

The minutes of the December meeting which were released yesterday gives us more reason to believe that we have not seen the last of the ECB’s efforts to steer market expectations higher again. In December, the central bank assessed that the “configuration of interest rates and expectations embodied in market pricing was not sufficiently restrictive”. After the temporary push higher in market rates over the year end, these rates are now close to where they were just ahead of the last meeting. While the ECB has officially moved to a meeting-by-meeting approach, it implicitly still sees it as crucial to its goals to guide longer-term rates. One should expect more micromanagement of market expectations in coming days.

More headwinds brewing next week, especially for EUR rates

The distance Bunds have put between themselves and the 2% mark is yet small when benchmarked against the overall volatility we have witnessed, but we think it should grow further. For one, we would be surprised if ECB officials were not to make good use of their final opportunities to steer expectations before the quiet period ahead of the February policy meeting kicks in next Thursday. Already scheduled to speak early next week are again Lagarde and Knot, but also Holzmann, on the hawkish end of the spectrum, and Panetta, who occupies the dovish end.

On the data front, we will get the flash PMI readings for which consensus is pencilling in a slight improvement. This would gel with the latest less downbeat data, but should also give the ECB additional room to tighten policies more aggressively than the market currently prices. Supply could provide a more technical headwind for rates markets with the EU slated to sell bonds via syndicated deals next week. The EU tends to be an issuer in longer tenors, although lately market expectations seem to have turned more towards a tap of an existing ultra-long bond as part of a dual-tranche deal rather than a new 30Y issue. Scheduled supply from the euro area sovereigns themselves is relatively muted, though markets are still waiting for new-issue deals from Spain and France anytime now.

Of course, one always has to take into account what happens on the other side of the Atlantic. The Fed will stay quiet next week ahead of its policy meeting, but we may still get some spillover from market reaction to US data. Most prominently, we will get the advance GDP reading for the final quarter of 2022, giving an indication of economic momentum late last year. We will also have the personal income and spending data, which will be scrutinized in the wake of the latest weak retail data readings. And crucially, the Fed’s favoured inflation measure, the Personal Consumption Expenditures price index, will also be released, where the consensus survey is pointing to a small uptick in the month-on-month core reading.

Today’s events and market view

Overall, we have already suggested earlier that the current levels of market rates look stretched. The upcoming policy meetings may eventually put the rally to the test, but it is for EUR rates that we see the clearest signs of headwinds brewing already near term – not just from last dash ECB communications, but potentially also data and supply. We think the least we should see is an underperformance of EUR rates versus the US.

The Fed’s Harker and Waller are the last scheduled speakers before the quiet period ahead of the Fed meeting sets in tomorrow. In Europe, we will hear from Lagarde again today, and given the limited impact of communications over the past days, she would have good reason to be more explicit.

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