Rates Spark: Running on Fumes

 | Nov 23, 2022 14:15

We see a case for the bond rally to extend in the near term but we expect the move to run our of steam ahead of the next weeks’ inflation and employment datah2 Drift lower in yields to continue for a few days but is increasingly running on fumes/h2

We didn’t have a potential OPEC output increase on our list of reasons why bonds should continue to rally this week but it clearly doesn’t hurt. Our reasoning had more to do with classic bond fundamentals. Even if winter has proved mild so far, and this may well change, we expect PMIs’ gradual slide lower to drive home the message that Europe is headed for a recession. What’s more, the Federal Open Market Committee minutes are likely to paint a less hawkish picture than Powell’s press conference did after the meeting. Both would be supportive for bonds, and help them extend their already impressive rally.

h2 The odds of a snapback higher in yields are rising/h2

There is one problem, however. We think this is the wrong macro move and the odds of a snapback higher in yields are rising. For one thing, the all-important batch of employment and inflation releases that starts next week could well trigger a wave of position-squaring from short-term longs. More importantly, volatility in economic releases, and the solid performance of US employment data so far in this cycle, means the bar for a further bond rally is higher and less likely to be met. Finally, as bond real rates drop, the odds of a pushback from central banks increases.

In the case of 10-year German Bund, this means any dip below 2% in yields is unlikely to last past the end of this week in our view. In the case of US Treasuries, any test of 3.75% to the downside is likely to set up another jump back towards 4%.

h2 The drop in real rates is a headache for central banks fighting inflation/h2