Bonds: UK gilts ‘far more skeptical about Brexit progress’ than the pound

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

US: 2.62% (+1bp)
UK: 1.35% (-1bp)
Germany: 0.56% (-1bp)
France: 0.84% (+0bp)
Spain 1.35% (-3bp)
Italy: 1.88% (-3bp)
Portugal: 1.88% (-3bp)
Greece: 3.69% (-10bp)
Japan: 0.07% (+1bp)

The yield on the US 10-year government bond rebounded on looming uncertainties regarding the deadlock on the US spending bill.

But the US 10-year yield fell as much as 5 basis points to 1.6076% since Tuesday, on relief that the US Congress agreed to pass a temporary spending bill to continue funding the government until February 8 following a three-day government shutdown.

The 10-year gilt yield eased 1 basis point to 1.35%, while the pound traded above the $1.40 for the second consecutive day. The divergence between the UK gilts and the US sovereign bonds narrowed, though the yield gap suggests that the gilt market is ‘far more skeptical about Brexit progress’ according to Citigroup strategist Jamie Searle.

"There is definitely a feeling that Brexit is now far more likely to be 'soft', which underestimates the risk for more problems ahead in our view but for the time being is leading to demand for [the pound]," said John Marley, head of FX strategy at Infinity International.

The UK labour data will be released on Wednesday. The UK’s unemployment rate is expected to remain unchanged at 4.3%, a forty-two-year low, for the sixth straight month. But the wages growth has likely stagnated at 2.3% excluding bonuses in the three months to November, lagging the inflation.

‘There were some early signs of job trends starting to turn, with employment down by 56k over the three months to October’ said analysts at HSBC, ‘and the claimant count rising for the third consecutive month in November. This, therefore may be the focus of the November release’.

In Europe, the flash PMI data will be released for January. Eurozone manufacturing PMI may have eased to 60.3 from 60.6, as the services PMI is forecasted at 56.4 compared with 56.6 printed a month earlier. Despite the slightly weaker expectations, the numbers remain strong and hint at a solid recovery in the economy, providing a stronger case for a hawkish shift in the Eurozone’s monetary policy.

The core-periphery yields within the Eurozone further narrowed. German and French 10-year yields were flat on Monday, while Spanish and Italian yields fell 3 basis points. The euro extended gains above $1.23 against the greenback.

The euro picks up momentum before the European Central Bank meeting due on Thursday.

Eurozone’s policymakers are expected to maintain the status quo on Thursday’s meeting. But investors will be focused on the accompanying statement, amid the ECB’s December meeting minutes spurred expectations that the bank could revisit its communication stance in early 2018.

Talks of QE tapering have driven the euro and the EU sovereign yields higher in January. And there may be more to be priced in according to some analysts. "The sooner the market realizes that the end of ECB tapering is coming, it will start asking itself what the next step is, and that’s ECB rate hikes. That’s not priced in yet," said ING currency strategist Petr Krpata. ING sees the euro at $1.30 by the end of the year.

In the short term however, the euro depreciation may delay the ECB’s plans to announce the QE tapering. "The recent rise in the euro and improvement in the economic outlook has been largely predicated on expectations that the European Central Bank (ECB) might tweak their guidance around the current bond-buying programme. Previous indications have suggested that the governing council will be reluctant to be too hawkish about their intentions as to when the programme will expire," says Michael Hewson, chief analyst at CMC Markets.

By Ipek Ozkardeskaya