Rates Spark: Migrating Doves

Geopolitical headlines will have helped, but front-end rates have more reasons to ease back from extremes. In the US, the Fed mulling MBS sales offers an alternate tightening avenue and in the UK the BoE's pushback against aggressive pricing should find a more prominent platform next week. But it is ECB doves that are passing on opportunities to push back.

Bond flows show some de-risking and a front-end flight

It's not been an easy market to read of late. Navigation of uncertain geopolitics and extreme macro circumstances has made it ultra-tough.

What we can see from the latest weekly flows data (through to the close on Wednesday) is an inflow to government bonds, especially into front-end products. There is certainly more value on the front ends with all this rate hike talk going on, but part of this also reflects some parking of cash and de-risking as the Russia-Ukraine stand-off continues

Flow reflect some parking of cash and de-risking as the Russia-Ukraine stand-off continues.

There is also evidence of re-risking in other asset classes, as there have been more outflows from investment-grade corporates, and the bulk of these outflows are from longer-duration products. High yield has seen outflows, and the largest in proportional terms is out of EUR-denominated high yield. Emerging markets too have seen outflows and this time including dedicated local currency outflows. Not an avalanche, but enough to be classed as a trickle that's persistent enough to worry about.

Demand for inflation hedges has turned, pushing real rates higher

Image Source: Refinitiv, ING 

Some of the macro stories can be gleaned from inflation-linked funds, which also saw more outflows. Assets under management in the inflation-linked products are down some 3% in the past month, helping to ease real rates higher. The only reason that real rates are not higher than they currently are in the fear factor is Russia - Ukraine, and the quality flight that could emerge should things turn sour.

USD and GBP front-ends coming off the boil

Actively selling MBS is an alternate and material Fed tightening channel

The Fed’s Bullard only yesterday reiterated his view that rates needed to be 100bp higher by mid-year to curb inflation. He occupies the very hawkish end of the FOMC spectrum, but market forwards is not too far off. They have SOFR in July at around 0.96%, i.e. 90bp higher from current levels, and maybe that is already too steep, hawkish comments notwithstanding. If the idea of actively selling MBS from its portfolio gains further traction within the FOMC, then this is an alternate and material tightening channel that can further take the steam out of front-end rates. 

Although we have seen levels come off the boil already, the aggressive pricing of policy tightening across the developed market space should remain in focus in the coming week. In the UK the Treasury select committee will quiz the BoE on inflation, and it could offer the Bank’s governor another platform to push back against aggressive market pricing. So far reiterations that “modest” further tightening would be needed have not restrained hike speculation in any meaningful way.      

Front-end pricing remains extreme, even after easing a little

Image Source: Refinitiv, ING 

ECB doves pass on the opportunity for forceful pushback

Official pushback against the pricing of two hikes already this year has been timid

Eurozone front-end rates may look equally stretched, though the difference here is that official pushback against the pricing of two hikes already this year has been timid. We find it noteworthy that the ECB’s Chief Economist and arch-dove Philip Lane passed on an opportunity to offer a more forceful verbal intervention yesterday, and instead retreated to a typical two-handed economist’s description of the policy options. Spain’s De Cos at least argued one should take the fragmentation of markets into consideration, a clearer acknowledgment of the rising sovereign bond spreads of late, and called for a gradual removal of accommodation.

Markets may get a better picture of the discussion behind the ECB’s hawkish turnaround at the last press conference when the minutes of the said meeting is published next week. But we doubt this will make the policy path much clearer with many officials have indicated that even the March meeting may well provide only monthly guidance. 

The ECB’s desire to keep all its policy options open will still have the market looking to the data for more guidance. In that regard next week will offer the PMIs which could show some improvements as governments have eased restrictions, and perhaps more importantly first country inflation updates out of France at the end of the week.

Today’s events and market view

Geopolitics remains a wild card in the near term which continues to put a damper on risk-taking and supports safe-havens. This has added to flattening pressure on curves but we see an avenue for curve steepening especially if front-end pricing eases. One factor that could help prolong the current situation though is the technical backdrop for Eurozone bonds. Next week will see limited supply from only Germany and Italy after Belgium canceled its auctions following the 30Y syndicated deal.

Today's data calendars are a quiet affair with US existing home sales and EZ consumer confidence data. The focus should remain on central bank speakers. ECB's Panetta will speak in the evening - usually an outspoken dove, but the topic of central bank digital currencies makes comments on monetary policy less likely. In the US we will hear from the Fed's Evans, Williams, and Brainard ahead of the president's day holiday on Monday.