U.S. inflation will test the bond market recovery

Bond Market Movers – Review and Outlook

What drove the bond markets last week?

• Hopes for the imminent reopening of the Strait of Hormuz have gained fresh momentum. U.S. President Trump called off threatened massive attacks on Iran and instead hinted at an imminent new agreement. Whether there has actually been any measurable progress, however, remains unclear.
• According to the ISM indices, sentiment in the U.S. economy im?proved noticeably in July, particularly in the manufacturing sector. The index for the services sector rose slightly.
• The ADP report for July was disappointing, showing job growth of just 44,000 in the U.S. private sector, the lowest figure since January.
• U.S. productivity grew more strongly than expected in the second quarter, while unit labor costs rose less than anticipated.
• For the first time in 15 years, the U.S. and Japan jointly intervened in the foreign exchange market to prop up the yen. According to media reports, the U.S. government is working to enable Japan to carry out such interventions without selling U.S. Treasury securities.
• U.S. tech giant Alphabet is issuing another large bond offering on the U.S. bond market with maturities ranging from two to 40 years.
• According to its latest quarterly refunding statement, the U.S. Treas?ury is leaving the issuance volumes of longer-term government securities unchanged. The medium-term outlook confirms that no changes to the issuance strategy are expected for the time being.

What could drive the market next week?

• The financial markets remain focused on developments in the Middle East and trends in commodity prices. The susceptibility to another disappointment is rising following the latest signs of easing tensions.
• Expectations for the U.S. jobs report for July have been dampened by the slightly disappointing ADP report. This increases the potential for positive surprises.
• The U.S. inflation data for July will be the macroeconomic highlight of the week. According to our forecast, headline inflation has slowed for the second month in a row. Meanwhile, we expect the core rate to remain unchanged.
• The primary market for U.S. Treasury securities will have to absorb the next wave of long-term bond issuance next week. Meanwhile, the primary market for euro-denominated government bonds is heading into the summer lull. Compared to the previous week, the gross supply is expected to drop sharply, from just over 25 billion euros to 9 billion euros, only. Nevertheless, net cash flows are set to remain slightly negative due to a lack of reflows.

Elmar Völker, Senior Fixed Income Analyst