The US 10yr yield wants to have a go at 4%, and senses a weak payrolls outcome (post the bleak Beige Book). Could be. But we think we'd then revert back up again. In the eurozone, we don't expect the French confidence vote on Monday to pass successfully, keeping uncertainty high. We therefore can't turn optimistic on French government bond spreads.

Image Source: Unsplash

The 10yr could target 4% on a weak payrolls, but even if so, expect a subsequent reversion back up again

Post Wednesday's bleak Beige Book, the bond market is sniffing out a weak payrolls report. We're putting on hold our steepening from the back end call as we face into this report, as the back end of the curve has rate-cut fever on its mind, and seems intent on focusing on potential jobs market weakness. The 10yr looks to have 4% as a level to aim for, depending on the payrolls number. Likely we'd need to see a number of below 50k to generate that type of reaction, and the closer to zero the more likely a 4% test becomes.

But we'd view any such move as an overshoot. Remember, we have a c.50bp swap spread to deal with. So a 4% 10yr Treasury yield equates to a 3.5% 10yr SOFR rate. That's really pushing up against the 3% area that the funds rate is anticipated to get to. Of course the 10yr rate can go wherever it wants to go to, but south of 3.5% on the current funds rate discount looks stretched. To get much below 3.5% we'd need to start talking about the funds rate getting down to 2.5%. We can of course have that conversation, but not till the actual data points us there.

While the market expectation of 75k for the August payrolls change is no more than a repeat of the July outcome, it’s interesting for two reasons. First, 75k is bang in the middle of the zero to 150k range, where the upper end is neutral for the economy while the lower end borders on the morph from a growth recession (sub-trend growth) to a pure recession (fall in output). Second, this report is laced with intrigue, as behind the numbers is a new Bureau of Labor Statistics head (as the previous one was fired by President Trump post the last number). So, if it's super weak, we'd likely believe that it's genuine. Whereas if its super strong (say closer to 150k), some might just doubt its credibility.

Bottom line, we maintain our steepening call from both ends of the curve as a call in the coming number of weeks, and through to year-end. But we acknowledge that this market has rate cuts and macro weakness as its immediate driver, which means more flattening from the back end is probable on a weaker-than-consensus number. As explained, that should be temporary though. Apart from a 3.5% 10yr SOFR rate being tight to the 3% floor being discounted for the funds rate, it will also prove tough for 10yr SOFR to hold at that level should core inflation begin to print there in the coming months, and we think it will.

French bond spreads ease somewhat ahead of Monday's confidence vote

In the space of eurozone bond spreads markets are gearing up for Monday’s confidence vote in France. The government is not expected to survive it and political betting platforms see Prime Minister Bayrou out with a probability of 86%.

French bond spreads, nonetheless, saw some moderate tightening on Thursday on the back of President Macron reiterating that he seeks to avoid calling new elections. The benchmark 10y spread over Bunds tightened 2bp to stand at 77bp. This is still a level reflecting a high degree of uncertainty ahead. There have only been a few prior occasions when spreads were noticeably wider, such as when the Barnier government toppled towards the end of last year. New elections this time around are still not entirely off the table. Also, given that fiscal consolidation is very likely to be prolonged and watered down we find it hard to turn more optimistic on French speads.

Friday's events and market views

The highlight will be US nonfarm payroll numbers, which consensus sees coming in at 75k for August, similar to the July reading of 73k. Besides the headline number any revisions should be closely watched. The unemployment rate for August is expected to nudge up from 4.2% to 4.3%. From the eurozone we have the second estimate of 2Q GDP numbers, which at 0.1% was still close to zero. Lower tier data includes German factory orders and Italian retail sales.

More By This Author:

The Door To A Potential Rate Cut In Poland In October Is Still Open
Risks To Czech Inflation From Wages And Emission Allowances
FX Daily: Mood On Jobs Worsens Ahead Of US Payrolls