European debt markets under pressure

In focus today

• Bond spreads in Europe remains a key focus this week after the French government yield spread to Germany widened to the highest levels since 2011 on Friday.
• From the US, we get the ISM Service index for September. The flash Service PMI data was very strong, so we will keep an eye on if the ISM index confirms that picture.
• In the euro area we receive the Sentix investor confidence indicator, which will show the first assessment of sentiment in October. The final services and composite PMIs are also released, which we expect to be close to the flash releases, like the manufacturing data on Friday that showed 52.9 compared to the flash of 52.7. On the wires, ECB's Schnabel is also scheduled to speak.
• From Sweden, we also receive the services PMI. There was a broad-based increase in the index in July, mainly driven by higher business volumes, while the price component declined and is beginning to approach a more normal level.
• Finally, we receive several services PMIs from Europe, including Italy and Spain, as well as final services PMIs from France, Germany and the UK.
• For the remainder of the week, Wednesday will bring Swedish inflation figures and the FOMC minutes, followed by the ECB minutes on Thursday. The week will end with inflation figures from Norway on Friday. Otherwise, the data calendar is relatively quiet, so focus will remain on geopolitical developments and European debt markets.

Economic and market news

What happened overnight

In geopolitics, the US has withdrawn B-1 bombers stationed at the UK Fairford Airbase, following a suspected terrorist plot to target the air base. The base has so far been used by US forces to carry out strikes in Iran, after former PM Keir Starmer granted permission in March.

What happened over the weekend

In the US, the September jobs report was softer than expected. Nonfarm payrolls increased by 29k, below consensus of 90k, while August was revised down to 133k from 162k. The unemployment rate increased to 4.2% (cons.: 4.1%, prior: 4.1%), slightly above expectations, and average hourly earnings disappointed at 0.1% m/m against expectations of 0.3% m/m. Combined with the larger-than-expected downward PCE revisions and dovish comments from key FOMC members, markets have cut the probability of an October rate hike to below 20%, down from around 70% on Tuesday last week.

In the euro area, September headline inflation increased to 3.8% y/y (cons.: 3.7%, prior: 3.2%), marginally above expectations, as also suggested by earlier country releases. Core inflation increased in line with expectations to 2.5% y/y (cons.: 2.5%, prior: 2.4%). The upside surprise in HICP was driven mainly by energy and food inflation, while underlying inflation pressures remained more muted. The increase in headline inflation supports the case for further ECB tightening, but the still moderate underlying inflation pressure points more towards a December hike rather than already in October.

Also in the euro area, the EuroCOIN indicator of euro area GDP growth points to continued solid growth momentum, at around 0.4% q/q in Q3. While it is not a perfect growth indicator, its historical correlation has been decent. The reading adds to the positive growth signals from the PMIs, Ifo and EC business survey seen in September. These signals are important to keep in mind amid the current risk-off sentiment in European fixed income markets.

In Norway, the seasonally adjusted NAV unemployment rate was unchanged at 2.0% in September, while August was revised down from 2.1% to 2.0%. This leaves the labour market relatively tight and below Norges Bank's latest MPR estimate of 2.1%, supporting current market expectations of further rate hikes. The details were more neutral, however, as the number of gross unemployed persons increased by 450 and new vacancies were broadly stable.

In commodities, Brent crude is trading around USD 101/bbl this morning after G7 leaders agreed to release 100m barrels of crude and diesel over the next four months following pressure from US President Trump, including a frontloaded diesel release within the first 20 days. The International Energy Agency (IEA) also said on Friday that its members have so far released around 325m barrels of oil from the 400m barrels pledged in March. It remains unclear whether the G7 release is part of the remaining IEA commitment or an additional release of reserves. Additionally, OPEC+ members agreed over the weekend to leave oil production targets unchanged in November.

In geopolitics, Yemen's Saudi-backed government has launched a counter-offensive to retake Houthi-controlled areas after the Houthis seized the Bab el-Mandeb Strait last month, a key global shipping route. The Houthis also claimed attacks on Saudi Aramco sites, though unconfirmed, adding to risks around continued oil supply, freight costs and energy prices.

Equities: Equities were markedly higher on Friday, mainly sparked by a softer-than-expected September job report (S&P 500 gained 0.7%, Nasdaq 1.2% and Stoxx 600 0.8%). Most sectors were in green, with cyclicals and yield-sensitive sectors such as consumer discretionary, tech and industrials, in the lead.

As such, global equities closed only marginally down last week, down -0.5% as a whole, despite the rapid increase in yields. Over the last two weeks, which is when most of the increase in the US 10y has taken place, equities are even up 0.4%. This is a way stronger performance than what normally would be the case given the speed of the yield increase. The same goes for market volatility. Although the bond vol (MOVE) has spiked, equity volatility has remained very low, at least on an index level.

Adding to this, the usually yield-sensitive tech sector has been the strongest-performing sector by far. Over the past week, the tech sector added another 1.5% while usual safe havens like health care, or for that matter banks, sold off -3%. Over the past month, the global semiconductor industry has rallied a full 10%. This is far from the textbook example of how equities and underlying sector performance would normally behave when a rates shock hits.

We discuss this divergence between the equity and bond responses further in yesterday's Editorial. However, in short, it makes full sense to us to see that volatility has been isolated in the bond space, as the relevant shock in equities is still earnings growth. We are in one of the strongest earnings cycles in modern history and this means that we need to treat equities different to other asset classes, as well as its own history.

FI and FX: The softer-than-expected US labour market report eased pressure on the Federal Reserve to cut rates, but the positive impact on the US government bond market was short-lived as 10Y US Treasury yields ended the day 2-3bp higher than the opening. There has been a modest decline in Asian trading this morning. The dollar strengthened this morning against both the EUR and the yen. The dollar moved below the 1.12-level vs. the euro and above the 158-level versus the yen. France is still very much in focus and keeps pressure on the EUR. Brent is still above USD 100.