Bonds: Gilt yields rise on BoE rate hike expectation

These were the movements in some of the most widely followed 10-year sovereign bond yields:

US: 2.86% (+2bp)

UK: 1.58% (+5bp)

Germany: 0.76% (+5bp)

France: 1.01% (+4bp)

Spain: 1.46% (+6bp)

Italy: 2.04% (+8bp)

Portugal: 1.99% (+7bp)

Greece: 3.62% (-2bp)

Japan: 0.08% (+0bp)

Eurozone sovereign bond yields resumed their march higher on Friday. German 10-year Bund yield advanced 5bps to 0.76%, Italian 10-year yield rose 8bps to 2.04%, as Portuguese 10-year yield added 7bps to 1.99%.

European Central Bank President Mario Draghi will present his annual report before the European Parliament in Strasbourg on Monday. Draghi will likely point at a solid recovery in the euro-area's economic activity, but sound cautious on low inflation.

On the data front, Eurozone and UK final services PMI data are due on Monday. British services sector may have expanded at a slower speed in January. The consensus of analyst expectations is 54.6 versus 54.9 printed a month earlier.

“Services PMI data for January will indicate whether the strong gains seen at the end of last year have been sustained into the new year” said Michael Hewson, chief market analyst at CMC Markets. He emphasised that International Monetary Fund (IMF) revised its growth forecast lower for the UK last month, despite upgrading its view for the global economy, particularly for Europe.

The yield on 10-year gilt advanced 5bps to 1.58% moving towards 'Super Thursday' this week, when Bank of England will deliver its latest monetary policy decision and the Quarterly Inflation Report.

The Monetary Policy Committee (MPC) is expected to maintain the bank rate unchanged at 0.50% at February 8 meeting. The BoE’s asset purchases and corporate bond target should also remain untouched at £435bn and £10bn respectively.

However, an upward revision to the GDP forecast, or a downward revision to the inflation could enhance expectations of an earlier interest rate increase in the UK.

The market has recently started considering two BoE rates hikes within this year. “That has not been necessarily factored in” according to Joshua Mahony, market analyst at IG, suggesting that the UK yields and the sterling could rise further.

UBS analysts commented that if the UK gets a transitional Brexit deal, there could be a BoE rate rise as early as in May.

Based on UK bond futures trades, the probability of May rate hike rose to 51.6%, from slightly above 30% at the beginning of the year.

The US 10-year yield closed 7bps higher at 2.86% on Friday, following a strong jobs report from the US. The US economy added 200K new non-farm jobs in January, versus 180K expected by analysts.

The December read was revised higher to 160K from 148K. But more importantly, the average hourly earnings surged to 2.9% year-on-year in January versus 2.6% expected by analysts; the previous month’s figure was revised up to 2.7% from 2.5%.

“The highlight of the report was that average earning,” said David Madden, market analyst at CMC Markets. “The impressive average earning figures has gotten the ball rolling in relation to higher inflation fears, and in turn bond yields are edging up.”

In addition, US bond investors are requiring higher yields, as they prepare for an eventual US government shutdown scenario on Thursday. The US government funding will expire on February 8.

Tensions among US bond traders rise as the deadline to another US government shutdown approaches with no long-term deal in horizon. Republican leaders said on Thursday that the Congress should agree on another short-term spending bill to avoid a government shutdown until March 22. According to Congressional Budget Office, the debt limit should be raised above $20trn by the first half of March, which is earlier than expected due to the significant tax-cut legislation.

Despite hard negotiations, the US government is not threatened by another government shutdown according to Senate Majority Leader Mitch McConnell. “One of my favorite old Kentucky country sayings is ‘There’s no education in the second kick of a mule,’ so I think there’ll be a new level of seriousness here in trying to resolve these issues”, he said.

The US government was closed for three days due to disagreement in January. The US funding turmoil will likely increase pressure on the short-end of the yield curve rather than the long-end, according to Citigroup Muhammed Apabhai, global markets head of Asia trading strategy.

By Ipek Ozkardeskaya