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In the US, the Beige Book is quite the sobering read - littered with tariff risk talk and at best flattish activity. Shaping up to be quite the week, with the pivotal upcoming payrolls to cap it off. In the eurozone, back end euro rates could come down a notch if US jobs data were to harm global risk sentiment, but the front end has a much higher hurdle to move.

That Beige Book is bleak
 

The latest Fed's Beige Book painted quite a bleak picture. If you are a coffee drinker, here's a snippet from the New York survey "A coffee roaster reported that tariffs on Brazilian coffee and on other supplies were creating shockwaves through the supply chain." Essentially the report was littered with tariff warnings on prices. Even second-round effects, as from the Richmond survey we had, for example, "A printer manufacturer that doesn’t import products experienced increased costs ranging from 5% to 15% from suppliers who were subject to tariffs." There was also mention of strains on household budgets, contracting opportunities in the jobs market, and flat to declining consumer spending. That's about as bleak a report as we've had from the Fed in quite some time.

Treasuries did not do a whole lot on the back of that, partly as it had already reacted to weakness in the JOLTS report earlier in the day. The curve even flattened on the day, as long end yields fell by more than short end ones. The 10yr yield fell on the day, but balked at breaking below 4.2%, settling above that level, while the 2yr did similar by bouncing off the 3.6% level to settle slightly above that. The 30yr yield fell impressively too, to just below 4.9%. That was the other big impulse to be aware of, the easing of upward pressure on long-end yields, helped by the 30yr UK gilt yield ratcheting lower for a change. That said, the upward pressure on the Japan 30yr yield continued (amazing value out there now when swapped back to dollars, on a synthetic yield in excess of 7%).

Despite the US flattening, we still thing steepening from both ends is the way to go ahead.

Big US job data surprises needed to change direction of euro rates
 

Whilst US rate spillovers have become less important for euro rates, the correlation could increase again if the US jobs market were to worsen. Upside data surprises in the eurozone have helped sentiment and with it the 10Y swap rate drift higher, against the direction of US rates. Smaller downside US surprises would not have much impact on euro rates, and the 10Y would be able to rise further. Bigger hits, however, would have a more negative impact on global risk sentiment. In such a scenario we expect the 10Y euro rate to come back down again.

A more severe downturn of the US economic outlook would also be needed to move the front end of the euro curve lower. The current spillover dynamics are mostly concentrated on the long end of the curve, all the way to 30Y rates. Rates up to 2Y are well anchored by market expectations of the European Central Bank cutting rates to 1.75-2%. The recent swings in Fed cutting expectations did little to change this. If, however, headlines about US recession risks would resurface against a backdrop of payrolls disappointments, markets would likely also turn to a more dovish path for the ECB.

Thursday's events and market view
 

The eurozone will publish July retail sales data, with markets also watching the ECB’s Cipollone as he addresses the European Parliament. However, attention remains on US labour market indicators: ADP payrolls are expected to show modest growth of 65k; Challenger job cuts are forecast to rise to 89k in August from 62k; and weekly jobless claims are anticipated to remain steady. The ISM services index is expected to edge further above 50, while Fed President Williams will discuss the economic outlook.

In primary markets, Spain will auction up to €6.25 billion in bonds, and France will offer a new 10-year benchmark as well as two longer-dated issues, raising a total of up to €11 billion.

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