Rates Spark: Whit Monday breather

EUR rates, and in particular European government bonds, should be underpinned by supportive technicals this week. Namely, supply is lighter than last week, and month-end maturity extension flow should be lending a helping hand. On the other side of the equation however, there is strong momentum in favour of higher rates. Data keeps surprising to the upside, and yields seem to be still in the midst of pricing in a world where central bank support is gradually withdrawn. As a result, the pause in the rise in EUR rates should prove only temporary, and it is too early in our view for bonds to experience a pre-ECB pause that would be caused by short-covering from momentum accounts.

The pause in the rise in EUR rates should prove only temporary

Given the drama surrounding the speed of PEPP purchases, ECB comments will once again be closely watched. It is probably too early for the central bank to start managing expectations ahead of its June 10th meeting, especially since we expect governing council members to hold contradictory opinions on the matter. There is also the hope that a stabilisation in EUR sovereign bonds markets, the epicentre of tapering angst so far, would imply less of a need for market intervention. In that regard the strong bull-tightening of Italian spreads last week was encouraging, but it faces 5Y/10Y auctions this week, as well as the prospect of a 30Y syndication in the coming weeks.

Stability on the part of USD rates would come as less of a surprise. After all, they’ve sailed through almost two months of solid economic data without batting so much as an eyelid. On the contrary, the economic overheating narrative has seen USD markets take inflationary signs as hints that the recovery is running out of road. This, and the Fed’s patient mantra, has caused inflows back into dollar-denominated bonds.

Narratives are fickle

Stability breeds demand for carry trades, which in turn helps supress yields. We see no impediment to this dynamic this week. In fact, the economic calendar is relatively thin and expectations are firmly set on a tapering announcement in the summer at the earliest. In a world where good economic news cause bond buying, it is hard to see what could upset the cart. The problem is, narratives are fickle, and we remain convinced that the US economic is on the verge of an economic boom that will keep inflation well above the Fed’s confidence band for the next years if left unchecked. The near-term stability in rates could thus turn into a dash for the exit in the medium term, we see the USD curve flattening 5s30s in most circumstances.