Taking stock of June’s central bank meetings). The Fed and ECB: both intended to look hawkish but with different sets of arguments
In our view this must be framed within a phase where central banks are now strongly immersed in a strategy of “expectations management”. Although with some differential nuances, both central banks seem to be focused on reining in any sort of excessively complacent/dovish reaction in the curves to the foreseeable moderation of inflation data in the months ahead (arguably not reassuring enough from the mid-term inflationary risk standpoint). The Fed has seemingly opted to leave the door open for further rate rises in 2H23 (in contrast to what the market has so far been discounting). In the case of the ECB, the strategy may now be more focused on introducing a new element of analysis in the inflationary risk context, as it is the upward trend in wages.
The recalibration of expectations is also having an impact on the rest of the curves, both in terms of direction and shape: regarding Bund yield reaction, the most relevant element may be not only the fact that it is now testing the 2.50% reference again, but the strength of the real rate component behind. The short tenors of the curves are still leading the movement and fuelling a high negative correlation between direction and slopes. Asset swap spreads are gradually moderating (the correlation of spreads vs. rates is now turning even more negative). We expect this process to consolidate in the weeks ahead.
Periphery outlook.
- In the peripherals, the round of central bank meetings has led to a generalised spread compression and flattening of the peripherals credit curves. Market participants are playing the European sovereign market with a convergent approach both in terms of credit spread tightening and curve slope convergence.
- The positive momentum for Italy is related both to tactical factors (short covering) and to strategic factors in terms of relevant inflows in the belly of the curve. This week the Italian Treasury might consider executing an exchange operation taking advantage of the recent flattening.
- As for Spain, last week’s performance showed a more pronounced spread tightening in the >15Y area on which tenors the yield dynamic showed a decrease on a WoW basis. The big focus at the moment is the Spanish elections, in particular in understanding which fiscal stance might be taken in the event of different electoral results.
- Looking to Portugal the healthy RV performance of PGBs in a bearish market was widely expected, benefiting from the lack of issuance and the allocation of PGBs in strategic portfolios. Waiting for “the new 10Y” Godot.
Weekly supply. On the bills market total issuance will be c.EUR17bn in gross terms but negative c.EUR5bn in net terms (redemptions in Germany). In bonds, core markets will see Germany active in the 2Y and 30Y area as well as Belgium. Total issuance will be c.EUR9bn in gross terms and -c.EUR4bn in net terms (redemptions in Belgium).