Rates Spark: US Midterms And Expanding European Government Bond Concerns

Tuesday will be nothing more than the day ahead of a much bigger day – Wednesday, by which time we'll have guidance on the midterm implications, and we'll have the US refunding announcement. In Europe, political jitters in Belgium highlight that France is not the only one struggling to consolidate its finances

The midterms and refunding loom large on Wednesday

Two things for Treasuries to get their teeth into in the coming days. First, the signals from the midterm elections. Expect this to be an issue for trading on Wednesday, as projections emerge through Tuesday night. The basic market discount is for the Democrats to take the House, and maybe the Senate. The only big surprise would be if the Republicans held on to both, which would be a huge surprise, as it would, in fact, suggest an endorsement from the US electorate for the war, tariffs and the current immigration policy, among other contentious issues that have emboldened the left and caused right-leaning independents to swing left. In all probability, this would be bond negative, on the theory that it's more of the same until disproven. The more probable blue sweep should have little market impact, as it should be broadly discounted.

The second big thing for Wednesday is the refunding announcement. At the previous one, there was a clear intimation of no change to the rhythm of issuance. And the questions posed to primary dealers a few weeks back did not suggest anything big or imminent in terms of change. However, there has been some growing talk of the refunding including a reduction in long-end issuance. More likely, if the Treasury were minded to do so, it would be an indication that it has the flexibility to do so going forward. Either that, or no change to the issuance profile, is probable. We don't think the Treasury needs to panic here by changing tack on issuance. Swap spreads are well-behaved. Better to leave such a policy for a time when there is a material need to tighten swap spreads.

European bond spreads will remain in focus for some time, and it’s not just France

The European government bond space has also moved back into focus at the start of the week, although France has fared better than one might have feared. In an unscheduled review, Fitch lowered the outlook on France’s A+ rating to negative, citing weaker growth, higher borrowing costs and a wider deficit since the August review. Nonetheless, the 10y OAT/Bund spread still tightened by around 4bp against the backdrop of a broader tightening in government bond spreads at the start of the week, which seems to have been driven by some easing of geopolitical tensions, with oil prices coming off their highs. To be fair, France has been trading at levels more akin to a BBB name for some time already, suggesting spreads are already wider than pure fundamentals would imply.

There was one important exception to the tightening trend. In contrast to the broader trend, 10y Belgian government bond spreads widened by up to 4bp versus Bunds. The backdrop was that the prime minister tendered his resignation after his coalition failed to agree on a budget. The King did not immediately accept the resignation and called on coalition parties to find a compromise. The King will receive the prime minister next on 6 November. The headlines underscore that it is not only France that faces the challenge of consolidating its finances. In the summer, the Belgian central bank forecast a deficit of 5.3% for this year and 5.5% in 2027.

Tuesday’s events and market view

Investors will be looking forward to the US midterm elections as the main political event of the week. In terms of data, the US will release the JOLTs job openings data for September ahead of Friday’s official payrolls data. In the absence of the data releases, the focus in Europe will be on a busy schedule of ECB speakers, including Kocher, Moulin, Nagel and Sleijpen.

In primary markets, Germany auctions 5y bonds (€5bn) and Austria sells 4y and 9y bonds (€1.73bn in total). The UK auctions 10y green gilts (£3.25bn).