Strategy Daily

Evelyne Gomez-Liechti | Multi-Asset Strategist (Mizuho International Plc) |

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Focus today turns back to US CPI, although realistically rates are still trading with one eye on oil and the Middle East. On the latter, the overnight news flow remains mixed rather than clearly de-escalatory. Pakistan and Qatar headlines gave markets enough to stabilise on Tuesday, but the broader story is still that both the US and Iran are hardening their public positions. That has kept Brent supported, back around $89.5pb, even if the immediate upside momentum has faded. For USTs, the stabilisation in oil allowed a relief rally. 10Y UST yields are back below 4.70% and 30Y back below 5.25%, while the curve was more rangebound than in Europe or the UK. The 3Y auction was well received and flows seemed quiet, but with $42bn 10Y supply today and CPI just ahead, it is hard to see the market wanting to take a strong directional view before the print. Our US economist is looking for a soft 0.1%MoM core CPI. The important point is not just today’s CPI, but whether another soft print is enough to convince the market that June was not a one-off. A soft number would likely increase the probability of another hold in September (12bp priced in the OIS strip at the time of writing), adding to July’s surprising drop in payrolls. For rates, softness should support the relief rally and probably the steepening trend, but we would still be careful chasing it. The house view remains that demand is still running ahead of supply, unemployment should continue to tighten, and the medium-term direction for rates is higher, including a Fed hike by year-end. In that sense, soft data may be more of a trading relief rally to fade rather than a regime shift.

EGBs are still very much trading off the oil tape, but yesterday’s price action was quite telling. Bunds sold off in the morning as Brent stayed firm and there was very little else for the market to look at, but once 10Y Bunds touched 3.20%, buying interest came in quickly. That level now looks quite respected, at least tactically, and the Pakistan/Qatar headlines then gave the market permission to rally. What stood out to me was not just the rally, but the curve flattening (buying the dip given the psychological 3.20% level + high gas prices preventing lower front- end yields?). Today’s local calendar has the German and Italian CPI, plus German 12Y and 27Y supply, but the real driver should still be US CPI and geopolitical headlines. I would also keep watching France. OATs underperformed in yesterday’s rally, while other EGB spreads tightened further, which suggests there is still something idiosyncratic going on in spreads (preparation ahead of the Autumn round of budgets?).

Gilts remain the higher-beta version of the oil/rates trade. The market again tested the 5% area in 10Y yields, but once oil was hit on the Qatar and Pakistan headlines, Gilts reversed hard and moved back through that level. That said, the curve still had more of a steepening bias than the US or Germany, which probably reflects the UK’s more uncomfortable mix of oil sensitivity, supply and fiscal risk. Today there is the £1.5bn 9Y linker auction, where demand could be helped by the extension backdrop, but this is unlikely to be the main event. The real test is still US CPI before focus shifts onto UK GDP tomorrow morning. A soft US CPI print can help extend the relief rally, but if oil holds near $90 and US data are not cleanly soft, I expect UK underperformance to reappear quickly.

Mixed session in Asian equities in an otherwise quiet session. Earnings releases came in positive, which helped offset the negative lead from US equities overnight. In Japan, JGB yields rose, with the 10Y point underperforming on the curve, although we note that the front-end also sold off meaningfully. The firm Tankan survey likely fuelled the hawkish repricing.

Multi-Asset Strategy Daily Mizuho International Plc 1

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