Core bonds started the new year in an extremely weak fashion

Markets

Core bonds started the new year in an extremely weak fashion. US Treasuries underperformed German Bunds as trading volumes returned to early December levels. The US yield curve bear steepened with yields adding 3.6 bps (2-yr) to 12.2 bps (30-yr). The move was almost equally driven by higher real rates and rising inflation expectations. The leap higher in long-term bond yields comes after them being depressed ever since omicron set foot on US soil. Despite record national infection levels, yields finally continued their natural path higher. Is the “bad” news discounted? The European example shows that the economic impact of omicron so far remains less worse than initially feared. The monetary policy context continues to play a role as well. The Fed’s December decision to accelerate the taper process could already result in a March rate hike with some governors even calling to shrink the balance sheet starting in Summer. This week’s US eco data could strengthen this hypothesis. The December manufacturing ISM kickstarts the action today with consensus expecting another 60+ outcome. The non-manufacturing ISM prints on Thursday. December ADP employment change, weekly jobless claims and payrolls will - from Wednesday to Friday - be indicative for the tightness on the US labour market. Meantime, FOMC Minutes (Wednesday) will provide us with more insight on the decision making process within the US central bank. These eco/events are expected to weigh additionally on US Treasuries. The US 10-yr yield returned to the higher end of the 1.37%-1.7% trading range in place since Q4 2021 with the upper bound serving as next resistance ahead of the 2021 high (1.77%). The German yield curve bear steepened as well yesterday with yields adding 2.5 bps (2-yr) to 5.6 bps (30-yr). We must add that Bunds underperformed US Treasuries for most of the second half of December. The German 10-yr yield leapfrogged from -0.4% to nearly -0.1% currently with the 2021 high waiting for a test at -0.06%. The European 10y swap rate already passed that technical reference, closing at 0.34% yesterday, the highest level since May 2019! Market expectations about the pace of a future ECB tightening cycle (start late 2022/early 2023) turned more hawkish since the December Frankfurt gathering. This week’s EMU eco calendar is less enticing than the US one, but we do get December inflation numbers on Friday. Subdued trading in FX space marks a stark contrast with action on bond markets. Yesterday’s US Treasury underperformance abrupted a test of the upside of the narrow trading channel in EUR/USD between 1.1186 and 1.1383. Sterling’s decent run since mid-December (BoE rate hike & positive risk sentiment) ran into EUR/GBP support just below 0.84.

News headlines

Key Turkish price indicators accelerated much faster than expected in December. Headline inflation jumped 13.58% M/M bringing prices 36.08% higher Y/Y, the fastest pace of price rises in more than 19 years. The core CPI index also jumped from 17.62% to 31.88%. PPI jumped at an even faster pace of 19.08% M/M and 79.89% Y/Y, suggesting inflationary pressures to stay. The jump in inflation comes as the unconventional policy approach of president Erdogan, forcing the CBRT to interest rate cuts, triggered a spiral of a free-fall of the lira reinforcing price pressures. With the CBRT last month cutting its policy rate to 14%, the real policy rate now reaches an extreme low of minus 22%. The Turkish government last month took some measures to shield TRY deposit holders from a weakening currency, but question is whether this will change the depreciation trend if the CBRT policy doesn’t change in a profound way. After an initial post-data loss, the lira yesterday closed modestly stronger at EUR/TRY 14.82.

The China Caixin manufacturing PMI again returned to expansion territory, rising from 49.9 to 50.9. Markets expected an outcome near the 50 boom-or-bust level. According to the Caixin statement, firms reported the strongest increase in output for a year due to an up-tick in total sales. At the same time, they labelled foreign demand as lackluster with export orders broadly stagnant. Capacity constrains also remain an issue as insufficient availability of staff prevents firms to work through incomplete business. Average input costs rose at the weakest pace in 19 months in December as price for commodities eased.

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