Developments in Japan look to be ultimately a higher rates narrative, as yen weakness exposes a dis-equilibrium that is unlikely to end well. We also think the short end of the euro rates curve can shift up as the probability for just two ECB rate cuts in 2024 should be more material. We await now the FOMC and US re-funding announcement on Wednesday.

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Refunding and FOMC focus, with the BoJ an ongoing higher rates issue (we think) in the background

The fall on global core rates post the apparent Bank of Japan intervention smacks of a temporary reaction. The underlying issue remains. Japanese rates are significantly below US ones, and if the Japanese yen can't appreciate versus the US dollar, then we don't have a steady state equilibrium. Facing that with FX intervention typically does not end well. The more obvious solution to this is for Japanese rates to rise. If they don't, something will have to give. And the bigger the hold-out, the bigger is the subsequent reaction. We continue to watch this space with a degree of concern. As a package, it suggests upward pressure on market rates generally, augmented to the extent that the US economy does not slow by enough to allow the Fed to cut rates in a timely fashion.

The next key impulse comes from Chair Powell's tone from Wednesday’s FOMC. A hawkish tint is likely, and this can in fact help to calm a back end that has been feeling very unprotected. But anything overly hawkish could cause the back end to get too worried on whatever risks the Fed sees. So, Chair Powell has a tough balancing act to perform. We also get the second quarter re-funding announcement from the US Treasury. We have no reason to expect a deviation of any note from the provisional refunding indications, which sees auction sizes in the 2yr, 3yr, 5yr and 7yr held steady at $69bn, $58bn, $70bn and $44bn respectively (historically high levels though). 10yr, 20yr and 30yr lines are upped for May, but then carved lower for June and July. Whatever the narrative, supply pressure remains elevated.

Markets interpret mixed messages as dovish

Spanish CPI numbers kicked off the week and they appeased markets by coming in just below expectations. But the message from German HICP was more blurred, slightly above expectations and 0.1% higher than prior reading. Given the early easter effect we hoped to see headline inflation a tad lower and thus, in our view, this data point should have pushed back against the observed easing of short end rates. Markets are set for a June cut, and so are we, but these inflation dynamics do not argue for a fast pace of easing thereafter.  

Perhaps markets are more focused on the disappointing economic sentiment indicators from the European Commission and the softening of selling price expectations. But the latter is still above historical averages for most sectors. Current market pricing is for 72bp of cuts this year, but in our view this should be closer to 63bp, which would imply a 50-50 for two or three cuts.

The back end of the curve has less potential to shift up, as the inflation risk premium has already been dragged up quite a bit by US markets over the past two months. The 5y5y inflation swap forward is now at 2.36%, well above the ECB target of 2.0%. This should give a bit of a buffer in case inflation numbers later in the week contain some upside surprises. We therefore see a tendency for Bund curves to flatten in the coming days.

Tuesday’s events and market view

Another day with eurozone inflation numbers, this time from France, Italy and the eurozone as a whole. Core CPI for the eurozone is expected to fall to 2.6% from 2.9% last month. Alongside we have GDP estimates for major eurozone countries and the eurozone, all of which are expected to come in close to zero. From the US we have the conference board data, which includes consumer confidence and expectations.

Supply wise we have a Dutch 10y DSL auction of €2-2.5bn and Germany a 5y Green Obl for €3bn.  The UK will auction GBP 4bn of 5y Gilts.

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