Last few weeks was marked by constant episodes of flight to safety, which was spurred by deteriorating fiscal situation in France but also fears of a broader AI selloff over concerns about further CAPEX sustainability of hyperscaler companies. Oil prices remained elevated into the weekend as the buildup of forces in the middle east rise the expectations of further joint US and Israeli strikes on Iran. This week is set to be more eventful (at least with regards to incoming data and central bank meetings), with several key central bank meetings and the upcoming elections in Israel on Tuesday.
Last week was marked by another episode of spread widening, in which the French 10Y spread (OAT vs. Bund) reached almost 177bps. What ensued was another flight to safety episode with a wave of selling pressure in OATs and subsequent rotation in to “safe haven” assets such as Bunds or USTs. This was also reflected in Bund options volatility, which rose again and remained elevated throughout the week. Notably, the volatility in OAT options is still heavily skewed to the put side, reflecting the demand for hedging. So far, further contagion in periphery markets remains relatively contained. French spreads tightened versus Bunds, after Moodys kept its rating unchanged on Friday evening providing some support until the budget crisis is resolved. Markets remain on the very edges of their seats until November 27th when S&P is expected to deliver its verdict on the French credit rating. Notice that this rating agency holds A+ with a stable outlook, so a rating downgrade before the budget is passed seems a bit unlikely.
This week also brings several key central bank meetings. Notably, on Wednesday we will have the FOMC meeting, where the Fed will decide whether to hold or raise rates. Market is currently pricing a 90% chance of a hold on Wednesday, so any deviations should remain remote even after the lates CPI print came in hotter than expected. What will be interesting to watch is the statement, and most importantly, the tone of the press conference, where we will again try to find clues as to what Chair Warsh has in store for the December meeting (where the market is pricing in a final hike this year). The AI facilitated selloff also adds another dimension for the FED path, as it did spur discussions of a slowdown in economic growth, as concerns over future hyperscaler CAPEX sustainability mount. The US 10Y remains under the 5% level, trading at 4.98% in yield terms.
ECB (on Thursday) is also widely expected to hold rates (market pricing 97% for hold). Recent episode of spread widening in France sparked fears of further periphery contagion, prompting questions of future ECB involvement. Deteriorating situation in France presents a challenge for the ECB, as the monetary policy transmission mechanism in the Eurozone is different than that of other countries, and can skew ECBs reaction function to remain more dovish than previously expected, although this remains to be seen. Currently, the main concern for the ECB remains the ever-looming risk of second-round inflation effects, which still appear to be contained (although further data will be needed to assess the spillover effects of the energy crisis). Elevated energy prices into the winter, and further release of emergency diesel reserves could prove to be detrimental for European governments, putting additional strain on already strained budget deficits, especially in more energy dependent nations. To add to this, current European gas storage is at 75% capacity. The German 10Y Bund sits around the 3.4% and is currently trading at 3.37% in yield terms.
As already mentioned, this week we will be receiving more data points than the quieter last week, with several key central banks included. To start the week, we will observe the US 2Y note auction on Monday evening. Tuesday’s Durable Goods orders, CB Consumer Confidence for October and New Home Sales for September will shed some light on the US consumer and the housing market. Wednesday we will be closely watching the Fed decision and the subsequent FOMC press conference (this week an hour earlier than usual due to the time change…). Thursday brings us the US GDP, and PCE, where we will see the trajectory of US inflation, and the state of the economy. This is followed by the ECB rate decision, and closely after, the press conference. To close the week, on Friday, we have the BoJ rate decision, followed by German CPI and GDP numbers, and Chicago PMIs in the afternoon.