Rates Spark: Flat bear

US inflation is not coming down in a hurry and, despite some encouraging signs elsewhere, it has given hawkish price action in rates globally another lease of life. This means flatter curves, and higher yields. 10Y Treasuries are now within touching distance of their 3.47% June peak and we do not see much that would stop it from beating that level. In fact we've laid out a path towards 3.75%, while still seeing a peak in the 3.5% to 3.75% range. Given the magnitude of the CPI surprise, we think markets would only react to a re-acceleration in PPI (consensus is for a deceleration) today, and ignore an outcome with less hawkish implications.

The recent strong run of US economic data could result in upgraded Fed forecasts

The next event is next week’s Fed meeting. Barring a well-informed press leak ahead of the meeting saying the opposite, a 75bp hike will remain our, and the market’s, favoured outcome. Of course, with now a 20% chance of a 100bp hike at the September meeting now priced in, it is tempting to call this peak hawkishness and to favour curve steepeners. There are still hawkish risks at next week's meeting however, even if one discounts a 100bp hike. For instance, the recent strong run of US economic data could result in upgraded Fed forecasts, and lend additional weight to the Fed’s hawkish tone.

Of course this resonates with other markets. EUR bonds are still licking their wounds after the European Central Bank (ECB) signalled a new hawkish reaction function, and GBP bonds are looking nervously to a Bank of England (BoE) meeting next week where a 75bp hike is also quickly becoming the market’s preferred outcome. All this is not an environment particularly conducive of bond performance, especially with primary market deals coming thick and fast. Despite difficult market conditions, the past four weeks have seen greater primary market activity than the average of the previous five years.

This is not an environment particularly conducive of bond performance

The main event of the day is the European Commission unveiling its energy support plan. Gas futures jumped yesterday afternoon but are still down significantly this month. For bond markets, the outline of the plan that appeared over the past few days could be the perfect combination of demand destruction (mandated consumption cuts), not aggressive enough action that it could materially change Europe’s economic trajectory (for instance via redistribution towards energy consumers), or that it would in itself cause a further cut in supplies by setting an import price cap, and reform of energy markets to avoid short squeezes.