Rates Spark: A Lot Not To Like For Bonds

Tough to see much progress on the US-Iran “talks” this side of the Trump-Xi summit. As we wait, Treasuries feel pain. EUR rates still closely follow the bear-flattening/bull-steepening dynamic alongside oil prices. It's not just oil as a driver for gilt yields; they remain pressured higher by worries politics could get fiscally more expansive

Another wait; takes us to the weekend. Another week, and US Treasury stress ramps

Given the importance of the US-China bilateral summit this week, the war with Iran is put on the back burner as a front-and-centre issue; at least for President Trump, probably. The messaging is clear – patience, and no agreement given what Iran came back with. In consequence, inflation expectations are re-ratcheting higher, and the US 10yr yield is back above 4.4%.

Assuming minimal progress and no lasting agreement for the rest of this week, the odds favour a trek in the direction of 4.5% for the 10yr yield. So far it's been steady and measured, and there, in fact, has been no material selling of Treasuries. Most of the yield movement has been a repricing in line with higher inflation risks. We run the risk of some outright selling, a more disorderly market.

We'll see CPI inflation on Tuesday, which will confirm headline inflation for April rounding up to 4% and core inflation rounding up toward 3%. Plus, there is every reason to expect that solidified from the subsequent May readings. With 10yr SOFR in the 4% area, it's only marginally above where headline inflation will print.

That tight real interest rate outcome keeps the pressure to the upside for nominal rates.

EUR curves still follow the oil price narrative, while UK yields face additional drivers

While oil prices rose and dragging rates higher alongside, there were also other narratives putting upward pressure to varying degrees across the different curves. In the eurozone, the bear flattening largely followed the accustomed inflation-driven curve dynamic. Markets nudged up the rate hike discount alongside oil prices to just over 70bp of tightening by year-end. The 10y Bund yield, meanwhile, rose a little further above the 3% mark but shows continued reluctance to venture too far from that mark.

The underperformer coming out of the weekend were sterling rates as UK politics have moved into focus following the local elections. 30y gilts rose as much as 9bp – compared to 3bp in Bunds – as calls for PM Starmer to resign are growing and markets eye the possibility of a successor following a fiscally more expansive route. The story is not just about the additional gilt issuance to absorb, but also about the Bank of England potentially having less room to ease over the coming years. This is shown by the fact that the 2Y rate rose almost in parallel with the 30Y. With gilt yields still relatively stable, we don't, however, see signs of threats to financial stability, as for example, during the Liz Truss episode in 2022.

Tuesday’s events and market view

The data highlight of the day is the US CPI release for April. Expectations are for the headline rate to rise to 3.7% from 3.3% year-on-year with the core rate accelerating to 2.7% from 2.6% YoY. Other US releases are the NFIB small business optimism and the weekly ADP employment figures. Goolsbee and Williams are the only scheduled Fed speakers.

The only notable release out of the eurozone is the German ZEW sentiment indicator, which is expected to sink deeper into negative territory. From the ECB, Nagel and Dolenc are expected to speak.

Primary markets will be busier with Belgium having announced a 5y syndicated sale alongside the scheduled auction from Germany (€6bn in 2y bonds) and the Netherlands (€2-3bn in 10y bonds). In SSAs, the EU announced a mandate for a new 7y bond alongside a 30y tap.

The UK will auction 5y gilts (£4bn) and after the 3y notes auction on Monday the US Treasury follows up with the sale of a new 10y UST on Tuesday (US$42bn).