Rates spark: More repricing risk at front end

Oil is practically back to pre-war levels, helping to ease inflation risks. The tail risk of oil returning to above $100 has therefore significantly diminished. Worsening growth dynamics, especially in the US, should start making rates at the short end of the curve look too high.

The front end looks particularly vulnerable to repricing lower

A further drop in oil prices is paring inflation risks and is making bonds look more attractive to investors amid fragile risk sentiment. Brent is now trading close to pre-war levels. Markets are nevertheless still positioned for 30bp of ECB tightening, but we think this hawkish pricing can easily be challenged if market sentiment turns more pessimistic. The risk of oil prices surging above $100 seems to be diminishing by the day, and therefore, the tail risk of the ECB being forced to hike by more than 25bp should fall.

With inflation risks moving to the background, investors could start listening more to growth concerns. For the US, in particular, we continue to hold the view that underlying economic dynamics are showing signs of weakness. Payroll numbers may look good at face value, but the decomposition shows little job growth in productive sectors. Meanwhile, stubborn inflation does not bode well for consumer confidence, which is already very low. Another drop in the savings rate data from May could hint at stress among a larger base of consumers.

We therefore continue to take the view that the hawkish repricing of the Fed has gone too far. More than 40bp of tightening over the next year seems excessive, given that lower oil prices are reducing inflationary pressures. So whilst we’ve seen some bull flattening pressure over the past few days on the back of worsening growth sentiment, we think the US front end has most repricing to do at current oil prices. A more benign core PCE reading of 0.2% MoM could help trigger such a move.

Thursday’s events and market views

The data highlight will be the US personal income and spending report. Decent retail sales should be reflected in good consumer spending numbers. But we may see a further drop in the savings rate, which is getting close to all-time lows. Core PCE is expected to come in at around 0.3% MoM based on CPI and PPI metrics already released. We see the balance of risks leaning towards a 0.2% outcome.

In terms of supply, the UK will hold a tender for a 2029 Gilt totalling £1.5bn, while the US will auction a new 7y note with a total size of $44bn.

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