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Euro rate markets seem to react very little to downside data surprises and geopolitical headlines, which does raise concerns over complacency. Nonetheless, this trend may persist for now as attention shifts to upcoming key calendar events, particularly US data releases.

Current markets display tight ranges and a very benign risk outlook
 

German Ifo data came in quite disappointing, which was a surprise given the backdrop of huge spending plans. Admittedly, the politics and practicalities around the implementation of the investment and reform programme remain challenging.

Earlier in the week, we also had some disappointment with the French PMI data. One could argue it is a reflection of the political challenges. In previous sessions, French government bond spreads over Bunds have continued to drift wider.

But overall, the market remains surprisingly steady – for instance, the pricing of the European Central Bank. The market is still indicating a roughly 40% chance of a rate cut over the next year. The 2y Schatz yield accordingly hovers just above 2%.

Further out the curve, the 10y Bund yield has hovered in a tight range around 2.75% over the past few days. 10y Bunds have become slightly more expensive versus swaps, but they still trade around 4bp above the swap rate, reflecting an overall relatively benign attitude towards risk. We also see many market indicators that point to very little risk ahead; implied volatility measures for both equities and rates are very low.

We think it is fair to ask whether markets are too complacent in the face of multiple risks. It seems markets have become accustomed to the political turmoil in France, although nothing has been resolved yet. And there is a continued insensitivity towards geopolitical developments. Even as some of the Russian incursions into NATO airspace appear to become more daring and the response from NATO becomes more tense.

For now, the appearance of complacency might be due to the notion that we are waiting for the next cues from the US, where the 10y Treasury is also little changed, waiting for more data to determine direction.

We still see the bearish direction of euro swap rates as our baseline scenario, but we also see plenty of risks that could quickly turn that narrative. Our baseline view of the ECB not cutting rates rests on the condition of growth continuing to improve, which is still a fragile assumption. As such, we still see good value in risk hedges, especially with shorter-dated German government bonds.

Thursday’s events and market view
 

The main events of the day are US data releases and Fed speakers. We will get the third and final reading of second-quarter GDP data, but more contemporaneous developments will be reflected in August durable goods orders and especially the weekly initial claims data. Fed speakers include those from both ends of the hawk/dove spectrum – from Schmid and Logan on the hawkish end, to Daly and Barr in the middle ground, to Williams, Bowmann and Goolsbee on the dovish end.

In primary markets, the UK is tendering 9y and 13y gilts for up to £2bn in total. Later that day, the US Treasury will sell US$44bn in new 7y notes.

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