This is the analysis of rates in the United States and the Eurozone.
US TREASURY, INFLATION AND THE RETURN OF BOND VIGILANTES
In the past week, the US Treasury rose to a new peak at 4.63%, in response to growing inflation fears; real rates increased by 15 basis points, reaching 2.09%, while break-even (BE) inflation remained relatively stable around 2.5%.
Rates rose following upside surprises on inflation. The Producer Price Index (PPI) in April grew by +1.4% (+6.0% year-on-year), while US inflation reached 3.8% (vs. 3.7% expected), driven by energy, food, and rents; core inflation rose to 2.8% year-on-year. Import prices accelerated to +4.2% year-on-year, doubling the pace observed in March.
On the other hand, consumption in the United States remains resilient: the retail sales control group increased by 0.5% in April, after an upward revision of +0.8% in the previous month. The China-US summit remained overall constructive, despite Xi Jinping’s more assertive rhetoric on Taiwan.
Oil prices are rising and the risk of military escalation in Iran is increasing. The market is pricing in a higher probability that the Federal Reserve will raise rates in the next 12 months, with a full hike priced in by March, despite the confirmation of Warsh’s appointment as the new Fed Chair. The repricing of about 30 basis points in US Treasuries suggests a return of bond vigilantes and indicates that fears of a global inflation shock are not marginal. Despite the recent repricing of US rates, we currently do not consider it appropriate to extend duration, as the market may require a higher premium for inflation risk and the impact of high fiscal deficits.
EUROPE BETWEEN WEAK GROWTH AND INFLATION CONCERNS
Bund yields rose to 3.19%; break-even (BE) rates settled around 2.31%, with slightly higher 5Y5Y inflation expectations at 2.19%.
Eurozone GDP data, growing by just 0.1% in the first quarter, confirmed economic weakness that could translate into flat growth in the second quarter (Q2).
The ZEW expectations index for the Eurozone showed a recovery from the previous month’s lows but remained in negative territory at -9.1.
The key data of the week will be the flash PMIs, expected to confirm continued strength in the manufacturing sector, while the services sector may show signs of slowing. The market continues to price in three rate hikes over the year (June, September, and December), supported by oil prices consistently above $100 and growing concerns about global inflation.
Our view on European rates remains neutral, despite the high levels, as fears of global inflation shocks are increasing and the current level of energy prices could force the ECB to maintain a hawkish stance.
ITALIAN SPREADS AND GOVERNMENT BOND STRATEGY
Italian spreads appear relatively compressed, while the risk of an economic slowdown in the Eurozone is increasing and could exert upward pressure on spreads.
Portfolios have slightly reduced the short position on relative duration after Bund yields touched 3.1%, but before the latest sell-off phase. Portfolios have also marginally increased exposure to Germany.
Overall duration will continue to be managed tactically; at present, despite the levels reached by Bund yields, we do not consider it appropriate to increase duration, as yields could continue to rise globally in response to renewed inflation fears.
Exposure to BTPs will also be managed tactically, but with a defensive orientation. Exposure on the yield curve is close to neutral, with a slight overweight on the 3-5 year segment against a moderate underweight on the 10-20 year segment.
EUROPEAN CREDIT RESILIENT BUT MORE SELECTIVE
European credit continued to show solid technical resilience last week, successfully absorbing investment grade supply near historic highs, supported by still robust demand, with spreads remaining close to contained levels. However, underlying sentiment has started to weaken slightly, as persistent inflationary pressures and high oil prices limit the margin for further spread compression, leading investors to adopt a more selective approach.
The investment grade index currently offers a yield of about 3.65%, with a duration of 4.5 years and trades at a spread of 77 basis points over government bonds. In relative terms, IG corporate hybrids offer a spread of about 125 basis points, while subordinated financials stand around 107 basis points; both are only moderately wider than the overall index and do not currently show particularly attractive relative value. The invested portfolio is about 53.3% in investment grade corporate bonds, while exposure to high yield represents 2.8% of the total.
