Rates Spark: Improving Sentiment

If history is any guide, rates should rise on higher sentiment indicators today, led by USD. The quarterly treasury refunding announcement could also put upward pressure on long-end rates.

USD rates are primed for a rebound

Purchasing manager’s surveys have had a distinct habit of beating expectations of late. We thought markets would have wised up to it by now but Monday’s price action proved this isn’t the case. If that pattern is repeated today, there is some ground to expect rates markets to reverse part of yesterday’s move. As we wrote earlier this week, we see USD rates as more susceptible to a rebound, as a flatter Covid-19 curve would allow them to digest weak economic data better. Another reason is that the US ISM published today is a first reading, whilst investors already had a glimpse of European PMIs.

Hopes of a 'phase 4' fiscal package will indeed be instrumental in any improvement in risk sentiment. Comments overnight were cautious with Mnuchin hoping for a deal by the end of the week. This comes at a time Fed officials, Daly in this instance, are calling for longer-lasting support for the economy.

A risk to this view is if the ISM's job component also points at the sector shedding jobs, or if the ADP falls short of expectations. Our US economist flags the downside risk to Friday's payrolls numbers and it is possible that markets do take a cautious view into the release if today's indicators forewarn of a weak jobs report.

The ECB QE data published on Monday afternoon does justify part of yesterday’s peripheral bonds rally. It paints a picture of a central bank still willing to deviate from its capital key to support peripheral markets, even as a noticeable improvement in spreads and market conditions have already been achieved. This is good news for carry seekers, we expect Italian bonds to remains positively correlated to Bund, but to outperform on rallies, a characteristic they acquire only when investors are relaxed about Eurozone systemic risks.

Today’s events: services sentiment, treasury quarterly refinancing

Earlier this week, the US treasury said it intends to borrow US$947bn in 3Q and US$1,216bn in 4Q. Today’s announcement will provide more detail about how this financing will be carried out. There is a widespread expectation that the treasury will be ‘terming out’ some of its T-bill issuance by replacing it with notes and bond supply.

Today also brings European PMI services, the Spanish and Italian releases are first readings. In the afternoon, the US equivalent, the ISM, will be published. In supply, Germany will tap its 5Y benchmark for €5bn.