Bond markets: Caught between Middle East concerns and softer U.S. inflation

Bond Market Movers – Review and Outlook

What drove the bond markets last week?

• The military conflict between the U.S. and Iran is intensifying. Iran has once again declared the Strait of Hormuz closed, while the U.S. has reinstated its blockade of Iranian ports. U.S. President Trump has threatened to escalate the attacks even further.
• Fed Chairman Warsh reiterated that the Fed would not tolerate persistently high inflation. His colleague Chris Waller suggests that interest rates may be raised soon if underlying inflationary pressures continue to rise.
• U.S. inflation fell much more than expected in June. This is due not only to falling energy prices, but also to a surprisingly sharp decline in the core rate. Producer prices reinforced the picture of significantly easing price pressures.
• Growth in U.S. retail sales slowed noticeably in June, while “core sales” continued to rise at a solid pace.
• China's economic growth fell short of expectations in the second quarter. Key economic data for the month of June, on the other hand, came in better than expected.

What could drive the market next week?

• The dire situation in the Middle East remains the focus of market participants. Will the recent escalation continue, or will the U.S. make a new diplomatic push to halt the latest rise in energy prices?
• The ECB Governing Council meeting is the monetary policy highlight of the week. Despite the recent turmoil in the Middle East, the European Central Bank is likely to stay put for the time being. ECB President Lagarde is set to avoid providing forward guidance.
• The ECB is releasing the latest survey on consumer inflation expectations. Moreover, inflation data for June will be released from the United Kingdom. The latter are unlikely to put any immediate pressure on the BoE to take monetary policy action.
• In the eurozone, the S&P Global Purchasing Managers' Indices and the ZEW Economic Sentiment Survey are set to be released. The key factor will be whether the recent escalation in the Middle East is already having a negative impact on sentiment.
• In the primary market for U.S. Treasury securities, the focus next week will be on the tap of the 20-year T-bond. Meanwhile, activity in the primary market for euro-denominated government bonds is likely to see a sharp decline compared with last week. We expect gross supply of only EUR 8bn, down from just over EUR 30bn the previous week. Despite only moderate reflows from maturities, net cash flows are set to remain just in positive territory.

Elmar Völker, Senior Fixed Income Analyst