Rates Strategy: So Far So Bearish

Sentiment data and technical factors could bring higher interest rates and wider USD-EUR spreads, but this could reverse if we get a poor US job report on Friday.

Source: John Hopkins University, ING

Strong data but wait for Friday

The combination of technical and fundamental factors has proved a particularly toxic combination for USD rates so far this week. To be fair, this same combination seems unlikely to be repeated. Yesterday delivered the now almost usual beat in sentiment indicators (peripheral manufacturing PMIs in Europe, ISM in the US). Today’s calendar is relatively thin in comparison, so government bond bears have to rely on momentum if they expect further rises.

The Covid news flow is not particularly positive but it does support our view of a widening of USD-EUR rate spreads reflecting the converging epidemic trajectories in the US and Europe. If a deal is reached between the Republicans and Democrats on a ‘phase 4’ US economic stimulus package we see a case for the move to continue. We think the potential is all the more interesting that it runs counter to the recent narrative of both the European health and economic Covid-19 responses, outperforming their US equivalent.

One potential snag to this view is likely to come on Friday with the US job report. Our US economist has made clear that risks to this release are skewed to the downside. How much of this is appreciated is yet unclear but barring a weak employment component in tomorrow’s ISM non-manufacturing, we think a disappointing US job report could send USD rates testing their all-time lows.

ECB QE data: From acute fire fighting to crisis management mode

Headline volume data for July showed what was to be expected. Total net asset purchases slowed from €159bn to €107bn – reflecting both a slowdown towards the summer months and a general improvement in market conditions.

Of more interest was the second set of bimonthly details for the Pandemic Emergency Purchase Programme covering the months of June and July. It shows that the programme has been increasingly geared towards the public sector, with those purchases accounting for more than 96% of the past two months’ €206bn in net PEPP purchases. This also reflects earlier successes in tackling tensions in other areas such as money markets for instance. With 3m Euribor OIS spreads now below pre-Covid times, it is no surprise that net Commercial Paper purchases have even been slightly negative after amounting to more than €35bn in March through May.

Within the public sector space the deviations from the ECB distribution benchmark, the central bank's capital subscription key, remain the main focus. Over the past two months, the ECB has also been able to moderate its initially heavy skew towards Italy, which accounted for 19.6% of public sector PEPP purchases versus 21.6% in March-May. This compares to a capital key implied share of 16.9%. In absolute terms, the ECB has so far spent more than €73bn on Italian government bonds via the PEPP, which is almost €13bn more than if the total of €357bn spent on govies had been split strictly according to the capital key. The additional purchases were made mainly at the expense of France and – in the past two months, but to a lesser extent – also Germany.

While absolute purchases in Germany have been closer to their prescribed share, it is important to note that the weighted maturity of these purchases – while increased to 4 years from 3.2 years – is still well below the 6.6 year average of the German government bond market. In risk-adjusted terms the relative impact of the ECB is decidedly lower in Germany. This is also the case for the Netherlands, while a reverse effect is observable for France, Spain and Italy.