Articles
22 October 2020

Rates Spark: Stimulus noise

As the US eyes, the stimulus prize and Europe tries to manage a deteriorating Covid-19 situation, the case for widening USD-EUR yield differential remains valid. The supply indigestion that added to higher EUR rates should prove transient, but today's 30-year Italian sale still needs to be straddled

Overnight: No improvement in mood music

Financial markets overnight proved unable to ride yesterday's wave of optimism, caused by the resumption of Brexit talks and reported US fiscal stimulus progress, much longer. Weaker stocks allowed government bonds to find a base amid warning against foreign election meddling in the US.

Near-term fiscal stimulus talk is noise, the 'blue wave' is the real prize

Talks surrounding more US near-term fiscal stimulus adds noise to the UST yields. Remaining reservations by Senators maintain doubt that sizeable package will come to pass before the elections. But markets very likely have set their eyes on the real prize already in terms of fiscal stimulus when Democrats get to power. A disappointment is unlikely to materially change the picture, and the chances that President Trump can use the upcoming debate to improve his polling seem slim.

The initial recovery of core rates yesterday supports our notion that the earlier push higher was at least driven in part by transient supply indigestion. The 10Y Bund yield briefly slid below 0.6% again. But the blockbuster €17bn EU SURE deal has also lured other issuers out their cover.

Greece sold 2bn in a 15Y bond reopening, and yesterday Italy mandated a 30Y sale. The latter's announcement pushed not only the periphery but also core yields higher again. To us, this suggests a growing overlap of in the investor base of long-dated core and peripheral bonds amid compression of yield differences and record low yields.

30-year Italy sale as yield convergence is put to the test

The convergence is currently put to the test by the deteriorating Covid-19 situation with more regions in Europe subject to restrictions or lock downs. In the case of Italy, a near term rating review by S&P this Friday could add to unease as government finances are stressed. Italy is rated BBB with negative outlook, a one-notch downgrade would leave Italy’s rating just above a feared ‘junk’ rating.

However, strong positives remain in favour of the convergence in the longer run. First the ECB, whose recent speakers have sounded increasingly dovish, still has a sizeable buffer left to intervene with it pandemic purchase program (PEPP) and expectations are that purchase programs are topped up before the end of the year.

Second the EU has just shown that it is able to raise the amount needed to fund its support programmes, even if the larger recovery fund itself still mired in the ratification process.

Today’s events: 30-year Italy sale, little data and a presidential debate later

The data calendar is light with US initial jobless claims, existing home sales and the European consumer confidence the only notable releases.

In the primary market, Italy drew confidence from the EU SURE launch earlier this week to mandate its own 30-year bond sale and stage a concurrent buyback of shorter maturity bonds. Both are anticipated to be today’s business.

Tonight, all eyes will turn to the presidential debate, though there appears to be little President Trump can do to turn the tide at this late stage.

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