Spark Pricing: Collateral Damage | MENAFN.COM

(MENAFN- ING) Deterioration of bond market fundamentals

In the world of DM rates, it’s fair to say that no bonds are in favor at the moment. The rise in yields was broad-based and accompanied by a toxic rise in implied volatility and market-based inflation expectations. The former suggest an erosion of the safe haven status of government bonds, the latter show the return to lingering concerns about inflation. That inflation swaps are rising even as markets forecast a higher path for central bank rates is a worrying sign. This suggests that even more aggressive hikes will fail to bring inflation under control.

Rising inflation swaps and volatility are a toxic cocktail for bonds

Refinitiv, ING

Of course, one should be wary of extrapolating a few days into illiquid markets, but the simultaneous rise in both bullish and inflation expectations reflects the fact that much of the inflation dynamic is beyond the bank’s control. central. This is particularly the case for energy inflation, insofar as it is fueled by supply constraints. Whether this is true over long periods of time is debatable, but this is not the first episode of initial rates and inflation swaps moving in unison this year. Together, they point to tough times for financial assets, as they imply neither an end to central bank tightening efforts nor an end to the overheating momentum of inflation.

How do rates trade in this environment? Upper. There will come a time when the amount of increases assessed by the GBP and EUR curves, respectively close to +250 basis points and +200 basis points in one year, will appear counterproductive in the face of the impending recession . This can only happen after the initial phase of an energy price jump. Rising commodity prices, and in particular energy, suggest that time has not yet come.

The 10-year US Treasury yield is expected to stay above 3% and likely near 3.25%

The drop in the US services PMI into sharp contraction territory (44.1; 12% below the breakeven at 50) sent US market rates down from their highs for the day yesterday. . However, the manufacturing industry continues to hang on (51.3%; moderate expansion).

Probably the right market reaction. The macro slowdown leaves less work for the Fed to do. The macroeconomic slowdown was generally highlighted, so no massive surprise for survey data to back it up. That said, when you look at previous recessions, what you’re really looking for are breaks below 45 for the PMI. In this sense, the 44 listed on the services index are worrying.

The PMIs are strange though, because even though we know the economy is primarily a service economy, it’s the manufacturing index that’s really driving sentiment. He has a long track record and has done a better job of telling us where the economy is heading. So far, this part of the mix has not yielded.

The 2s5s10s butterfly peak also suggests the peak is for 10Y returns

Refinitiv, ING

Looking at the positioning of the 5yr on the curve, it is now approaching a more neutral valuation (only 2.5bp rich, having been as high as 10bp rich; or double if looking at the raw measure) . We are monitoring this carefully. So far, its valuation is still consistent with the 3.5% turn for the 10-year in June.

Any significant drop in a cheap 5-year valuation could accentuate this position and question whether this was the peak. We still believe this was the case, as there is insufficient evidence to refute this view at this point. The basic view remains that we are picking up the 10-year Treasury yield, heading towards 3.25%.

Green bonds are a collateral victim of deteriorating market liquidity

With implied rate volatility surging again, energy prices pushing short- and long-term inflation swaps higher, and general liquidity conditions deteriorating, the time now seems right to illustrate the profound consequences of this market regime. Rising rates undermined the valuation of many assets with long implied duration beyond even bonds. The end of abundant liquidity has also drained demand for marginal speculative assets. But deteriorating liquidity conditions have also affected an unexpected corner of financial markets, green bonds.

The contraction of German greenium can be attributed to the drop in market liquidity

Refinitiv, ING

Although we have always agreed on the existence of greenium, a tendency for green bonds to trade at lower yields than their peers, we were frustrated to find no consistency in the way they are valued d one curve to another. Moreover, the lack of correlation between greeniums within the same curve, or from one curve to another, suggested to us that there is no green factor. The receding tide of liquidity is changing that. Increasingly, we have observed that sovereign and SSA (sub-sovereign, supranational and agency) greenium is influenced by liquidity conditions on these curves. In other words, in times of low liquidity, greenium tends to contract.

This is an interesting finding because, despite expected deals from Germany, Belgium and the UK this fall, green bond supply is showing signs of stabilizing after years of skyrocketing growth. It’s too early to tell if supply has finally caught up with demand, but our analysis suggests less pressure in the green bond market, so it makes sense that macro factors such as liquidity are starting to assert themselves as factors. daily engines of the greeniums.

Today’s events and market view

Most of today’s releases relate to the US economy. A preliminary look at durable goods orders for July will be the highlight. Pending home sales are expected to decline further.

Germany will auction 10-year debt for 4 billion euros under difficult conditions, although the recovery in yields from previous sales will no doubt be seen as an opportunity.


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