Articles
1 October 2020

Rates Daily: Payback time

Seasonal factors and supply should mean a temporary setback for rates direction. We expect the grind lower in rates to resume afterwards, and to increase the directionality of the EUR long-end

EUR rates: temporary bearish factors

Factors pointing at a rise in EUR rates today are temporary but potentially potent. Firstly, core bonds can no longer rely on the month-end extension flow thrust to propel their long-end. This is all but a temporary setback in our view and the balance between government supply and demand should improve into year-end, as Germany's borrowing plans have demonstrated.

Long-dated auctions from France and Spain today add to the challenge but this should prove short-lived. Price action in September was characteristic of government bonds about to break through new lows with small, incremental daily drops in yields. On balance, we expect this trend to continue even if a number of technical barriers, such as the 0.55% repo rate for 10Y Bund means other sectors of the curve would outperform on a rally.

EUR long-end: approaching the danger zone

The natural conclusion should be that the long-end gains in volatility relative to the rest of the curve when rates drop. Whilst this has been true in recent years, that relationship seems to have broken down in the past six months. We think the diminishing directionality of the long-end is more a reflection of the low realised volatility in rates rather generally than a reflection of a more durable curve regime change. In plain English, the potential for an aggressive EUR flattening remains intact even after the recent period of calm.

This is all the more important with 30Y EUR swaps pushing deeper into negative territory, and approaching their lowest level since the dash for duration in the middle of March. Inflation forwards as a driver of long-end performance could also gain in relevance, with spot dipping further into negative territory.

In the near-term, the best chance for that asymmetric curve flattening move not to happen is if confidence in a Biden victory and a Democratic sweep in one month’s time give more credibility to reflation hopes. The combination of pro-growth fiscal policy, higher supply, and a Fed new inflation target have the potential to propel long-dated EUR rates higher in sympathy with their USD counterparts. The two have shown an ability to diverge however, and the road to a final election result is a rocky one.

USD rates: pushing at, but failing at, boundaries

The ease at which the US 10yr jumped from 64bp to 70bp yesterday was partly a function of market positioning. Some of the duration longs that had been built in the previous week had been pared back, and the benchmark duration extension trade on the last day of 3Q was much shorter than is typical.

But even then, the 10yr struggled to make a successful break above 70bp. That remains a tough nut, and it seems now that the next big information will come from Friday's payrolls report. As we head into that report, we think market expectations could be skewed higher than the macro consensus, implying that a much bigger number would be required to really push the 10yr above 70bp.

If we don't get that (and we don't think we will), then we're back to testing the low-60s bp again. A sustained move to the upside in rates really needs a vaccine moment, until then, elevated volatility and uncertainty lie ahead into the presidential elections. Agreement on a fiscal package is another factor to watch for. It seems the Trump administration wants something tolerable pushed through. That would counter any significant lurch lower in market rates.

Soundbites overnight on that front were encouraging: both Pelosi and Mnuchin made supportive statements. Significantly, the Treasury $1.62tn proposal includes more support for states and local authorities, and a $400/week federal unemployment benefit running through to early January.

Today's events: Spanish and French supply, manufacturing surveys

Spain (5Y, 10Y, 13Y Linker, and 46Y) and France (10Y, 14Y, 20Y, 32Y) will carry out longer-dated debt sales today.

In data, the focus turns to manufacturing survey indicators. The Spanish and Italian PMIs are first readings, so is the US ISM.

Content Disclaimer
This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more