Rates Spark: Will German And French Pmis Keep Our Bearish Rates Outlook Supported?

Consensus sees the eurozone aggregate PMIs remaining above 50, reflecting a gradual growth recovery and supporting a drift higher in euro rates. But more important could be the French and German numbers, since these are the two economies featuring prominently in the region's downside risks. Expectations are for the German manufacturing index to nudge from 49.8 to the 50 break-even level. The last time this level was hit was in 2022. And with the German fiscal impulse still ramping up, such numbers argue in favour of some careful optimism.

More worrisome could be the French PMIs, whereby weaker numbers would pose an additional challenge to the fiscal outlook. We think spreads are still on the tight side, and worsening growth dynamics could be a catalyst for a repricing wider. Spreads should, in our view, also widen versus Spain and Italy, which not only see stronger PMIs but also received rating upgrades this month.

Although it isn't our baseline, we are also aware of the broader downside risks to euro rates if PMIs fail to continue their recovery. Markets won't immediately extrapolate one bad reading, but a series of disappointments would bring more European Central Bank cuts back to the table. At the moment, the inflation outlook is very benign, which means the ECB does have room to cut if needed, which would then pull down 2Y rates. Meanwhile, the back end of the curve should remain more anchored on the prospect of fiscal support in 2026 and 2027.

The PMIs take centre stage today. For the eurozone, the consensus expects virtually no change, with the manufacturing index to come in at 50.5 and the services at 50.7. Looking at the country level, Germany is seen improving subtly, though with services staying below 50. French PMIs are expected to soften, with manufacturing barely above 50 and services already below. ECB speakers on Tuesday are Georg Müller, Martin Kocher and Piero Cipollone.

In the US, the S&P PMIs usually get somewhat less attention than the ISMs. In any case, they are expected to come in slightly softer, but still reasonably well above the 50 threshold. Manufacturing is seen coming down on point to 52, services by half a point to 54. What should get attention are the public appearances of Federal Reserve officials, with Chair Jerome Powell, Michelle Bowman and Raphael Bostic scheduled to speak on the economy.

In primary markets, the Netherlands will sell a new 30y DSL via Dutch Direct Auction (DDA). Portugal has mandated banks for a new October 2033 bond and a tap of a 30y line. Germany sells €4.5bn in the 2y Schatz, while the UK sells £1.5bn in 30y gilts. The US Treasury sells US$69bn in new 2y notes.

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