Yields surge, France under pressure, US jobs disappoint

Preview: Global bond yields hit multi-decade highs, the OAT-Bund spread blows out, and weak US payrolls hit Fed hike bets.

The week that was

Bonds in the spotlight

Bonds were firmly in the spotlight again last week. Global government bond yields rose. Honestly, it feels like we are selling off every day at the moment, and whenever there is a bounce, market participants are ready to sell. Yields are now at multi-decade highs across the US, UK, and Europe, driven by a range of factors, including the ongoing global energy shock from the Middle East. Of interest, stocks are still treating these higher yields as someone else’s problem. Time will tell how this plays out. 

The spread between French 10-year OATs and German 10-year bunds widened to an eye-popping 140 bps, suggesting this is about France rather than a shared inflation shock; the market is pricing in credit risk. To put this in context, we are nearing crisis levels, as seen in 2008 and the dot-com bubble. If you are a French bondholder, this is not a pleasant picture.

Unlike the US, France is part of the eurozone and cannot simply rely on the ECB to absorb its debt. The ECB does have a bond-buying backstop – technically known as the ‘Transmission Protection Instrument’ (TPI). However, France would not meet its fiscal criteria, so any rescue would be a political decision rather than a market fix. Raising taxes in France would also not go down well with its citizens; I think France already pays some of the highest tax rates in the eurozone. Economic growth in France is lacklustre, and cutting spending is likely to trigger strikes and protests.

RBA hikes its cash rate – CPI lower

On the macro front, the RBA raised the cash rate by 25 bps to 4.60% last Tuesday amid ‘some of the upside risks to inflation materialising'. This marks the fourth hike this year. While Governor Michele Bullock said that more rate increases are on the table, the Board considered both a hold and a hike at this meeting. I believe that comment prompted the market to fade the initial AUD upside. For those connected to the wires, that comment offered a good opportunity to scalp short. 

Annoyingly, the August Aussie CPI inflation was released the day after the RBA decision. Given Bullock’s ‘hold and hike’ remark, I was looking for a downside surprise in these data. Headline inflation rose to 4% YY from 3.5% in July, but stayed slightly below the 4.1% consensus. The RBA's preferred trimmed mean held steady for a third month at 3.6% YY. I was not expecting AUD/USD to sell off on a flat YY trimmed mean, but it did. I think traders reacted to both the headline and trimmed-mean MM prints coming in below expectations.

Soft US PCE

From the US, the August PCE numbers were released last Wednesday and came in below expectations across the board. Although there were changes to the BEA’s methodology, price pressures remain above the Fed’s 2% target – in fact, they have done so for more than 5 years. YY headline matched July’s 3.4%, defying the market’s 3.7% consensus, while YY core also matched July’s 3%, rejecting the 3.3% estimate. The market reaction was difficult to trade, with the buck swiftly reclaiming lost ground.

US payrolls miss

The September US employment report then hit the wires last Friday. Headline payrolls came in at 29,000, well below the market's median estimate of 90,000 and August's initial reading of 162,000. Revisions then took 31,000 off July (now -10,000) and 29,000 off August (now 133,000), leaving the two months a combined 60,000 below previous estimates.

Unemployment ticked up to 4.2% from 4.1%, though unrounded, the rate rose only from 4.14% to 4.18%. The household survey showed the labour force growing by 485,000, with 406,000 more employed and 78,000 more unemployed. The unemployment rate edged up as unemployment rose 1.1%, faster than the labour force's 0.3%, while participation rose to 61.8% from 61.6% as the labour force outpaced population growth.

The week that is

The week ahead is relatively quiet

Today brings the September US ISM services PMI at 2:00 pm GMT, with Wednesday focussing on the minutes from the latest Fed meeting at 6:00 pm GMT, and Friday shifting attention to the September Canadian jobs report at 12:30 pm GMT.

Today’s ISM data will be a key watch, particularly after Friday’s US payrolls miss. If we see the headline miss and a push lower in the prices paid component, this would likely trigger USD downside and prompt traders to all but fully price out an October Fed rate hike. Right now, investors have assigned about a 20% chance of a rate hike, down from about 70% just a week ago. This was largely due to the US data I wrote about above and a couple of key Fed officials recently coming in less hawkish. 

We then have the Fed meeting minutes. While these will give us a granular look at the internal debate that led to a unanimous decision to hike the Fed’s target rate by 25 bps, they do not factor in recent economic data. 

The bond market will be another major talking point this week, especially for French bonds. If the OATs/bund spread continues to widen, this could further weigh on the EUR – look at EUR/USD this morning! This is driven by the threat of eurozone fragmentation and capital flight, and, of course, it puts the ECB in a sticky spot.