Following an already eventful week, the financial markets are bracing for more developments as we approach Friday. This day is anticipated to be a focal point in the financial calendar, although the repercussions on other market segments seem to be mitigating. Additionally, there’s an anticipation for a steeper yield curve after a period of relative flatness. Moreover, as investor sentiment starts to gain a positive momentum, government bonds are expected to begin underperforming in comparison to swaps.
The Eurozone’s Interest Rate Dynamics
As we draw closer to concluding a week filled with significant economic events, the markets are yet to fully unwind with the upcoming eurozone inflation figures and US employment data still on the horizon. The escalation in eurozone rates, notably at the shorter end of the spectrum, underscores a burgeoning belief among investors that the European Central Bank (ECB) will sustain its policy rate at 2%. Should this narrative gain further traction, it is foreseeable that the 2-year rates could ascend by an additional 10 basis points.
However, it’s crucial to highlight that there’s still potential for adjustment at the longer end of the euro yield curve. This segment has lagged, especially considering the narrowing of the 2s10s spread by approximately 10 basis points since its zenith in mid-July. Several factors contribute to the expectation for a steeper curve. Firstly, an improvement in risk sentiment, spurred by recent economic data releases and diminishing trade uncertainties, is likely. Secondly, the ongoing discourse around enhanced fiscal stimulus, anticipated to carry forward, coupled with an increase in issuance, is expected to exert upward pressure on longer-term interest rates. Lastly, the push towards higher rates at the longer end of the curve aligns with a global trend, hinting at potential spillovers.
In the meantime, the spread between 10-year Bund yields and swap rates is converging towards zero once more. Nonetheless, as risk appetite strengthens, it’s projected that Bunds will start underperforming. Despite their reaffirmed status as a safe-haven asset amidst the recent trade tensions, the prospect of reaching trade agreements could dampen demand for Bunds. Although the path ahead might still encounter turbulence, for instance, due to potential escalations with countries like Canada, the basis points spread between the 10-year Bund yield and swaps, notably after Germany’s announcement on spending, indicates room for further divergence.
US Employment Data’s Impact
The upcoming release of US payroll figures could have a significant impact on the financial markets, potentially overshadowing Federal Reserve Chair Jay Powell’s hawkish statements from earlier in the week. A pronounced slowdown in job creation could compel the Federal Reserve to reassess its stance, yet the consequences of tariffs are unlikely to be ignored. An unexpected downside in payroll numbers might most starkly be reflected in the middle of the yield curve. The front end is expected to remain relatively stable due to inflation concerns, while the back end grapples with global fiscal pressures.
Interestingly, the correlation between US payroll data and euro rates in 2024 has decreased markedly. Hence, while a substantial surprise in the US data could lead to significant movements in US rates, the overflow effect into euro rates might be limited. However, the relationship between US movements and rates in other tenors, particularly in longer maturities, maintains a stronger connection.
Looking Ahead to Friday’s Economic Updates
The consensus forecasts suggest that eurozone headline inflation will stabilize at 2.3% for June, with core inflation slightly below the target at 1.9%. On the other hand, US employment figures are expected to show a cooling, with new jobs added likely to be significantly lower than in previous months. The unemployment rate is also anticipated to marginally increase. Other noteworthy releases include trade balance figures and sentiment indices, both of which are expected to show slight improvements.
Moreover, the evolving landscape of trade deals, particularly concerning the United States, commands attention. With President Trump extending the deadline for trade negotiations by a week while also increasing tariffs on specific countries, including Canada, trade-related news is likely to remain a hot topic.
Conclusion
As the financial markets navigate through the turbulence of economic indicators and geopolitical developments, the anticipations and actual outcomes of these events continue to shape investor sentiment and market dynamics. The balance between cautious optimism and the underlying uncertainties underscores the complexity of predicting market movements. However, staying informed and understanding the broader economic context helps in navigating these challenging times.
Disclaimer: This article has been prepared solely for informational purposes, without consideration of any specific user’s financial situation, objectives, or means. It does not constitute investment advice, nor is it a solicitation or offer to buy or sell any financial instruments.
