The PCE data suggested that inflation heated up less than expected in August, while Friday’s official jobs figures showed a softer-than-expected NFP number and weaker wage growth. According to the data, the US economy added just 29K new nonfarm jobs in September, the previous two months’ figures were revised lower, and annual wage growth unexpectedly slowed to 3%. The unemployment rate, on the other hand, edged up to 4.2%.

The softer-than-expected data initially pulled the US 2-year yield lower as investors scaled back their rate hike expectations, before the yield rebounded. A closer look at Friday’s data hinted that the jobs report was not that catastrophic after all. EPB Research, for example, highlighted that ‘cyclical payrolls’, such as those in construction and manufacturing, which are more sensitive to interest rates and broader macroeconomic conditions like credit and capital spending, provide a clearer signal of whether economic weakness is spreading or reversing, and whether economic momentum is improving or worsening. Construction and manufacturing payrolls reached a new cycle high in September. That, according to EPB analysts, is stronger evidence of a genuine cyclical upturn. Voilà.

Regardless, expectations of an October Fed hike melted away over the course of last week. Before the data, markets priced in a more than 60% chance of a 25bp hike. This Monday morning, Fed funds futures price in a less than 20% chance of a hike. Inflation remains high, but the latest data don’t show an alarming acceleration, and the jobs data look softer – at least judging by the headline figures. The US 2-year yield is consolidating near 4.80% this morning, after approaching 5% last week. The 10-year yield, however, is pushing higher, and the spread between the two is now wider – at around 46bp. The easing of near-term Fed hike expectations is also comforting for broader risk assets.

As such, the S&P 500 ended Friday with a 0.73% jump, close to its all-time high, while the Nasdaq 100 traded at a fresh record high. Asian technology stocks opened the week on a positive note, yet the still-negative mood across global bond markets remains in the headlines despite cooling energy prices. If the bond selloff continues this week, major indices could find it difficult to maintain their gains.

This week will be rather calm in terms of major data and events: we will get a series of PMI and ISM readings today, and the Fed minutes on Wednesday. But in the absence of major news, attention will remain on bond markets – especially European bond markets!

Bond market’s temperature remains high

Last week, the spread between French and German 10-year yields spiked past 150bp – its highest since the euro debt crisis of 2011–2012 – and the widening spread is notably weighing on the euro. The EURUSD just slipped below 1.12 – a 17-month low – and the euro is also losing significant ground against sterling and the Swiss franc. Options markets show investors paying a hefty premium to hedge against further euro weakness. In summary, no one wants to be sailing in euros as the wind picks up.

Moving forward, higher yields alone won’t convince investors to come back if confidence in the country’s ability to put its finances in order keeps deteriorating. And higher borrowing costs gradually make that task harder: more money goes into servicing debt, leaving less room for everything else. The political situation is not bright either: the increasingly popular far right’s ambitions don’t suggest budget discipline. The problem is that politicians need investors to play along to finance their ambitions. If investors say no, then it’s no. Look at Great Britain if you don’t believe me.

For the broader euro area, what would worry me most is a sustained widening in other countries’ spreads. Today, we see Italian, Spanish, Portuguese and Greek yield spreads over Germany widening as well, but they are nowhere near their 2010–2012 levels. They suggest only limited stress across the area for now. But we should watch whether these spreads widen further: a notable increase would suggest that investors are reassessing European risk more broadly, rather than simply demanding more compensation to hold French debt.

This week’s auctions will give us some clues about where investors’ appetite stands. France sells short-term bills today, Austria comes to market tomorrow, and Germany sells seven-year debt on Wednesday. It will be interesting to see whether demand remains healthy outside France, or whether the nervousness starts spreading. Across the Atlantic, the US 10- and 30-year auctions could add another layer of pressure: if investors demand still higher yields there, European bonds may struggle to find relief.

Staying in Europe, thankfully, the European Central Bank (ECB) has a tool called the Transmission Protection Instrument, which allows it to buy government bonds to counter unjustified, disorderly market moves. But there is no magic spread level that automatically triggers ECB intervention, and support comes with conditions. The last thing the ECB wants to do is finance a country’s spiralling debt. It therefore assesses fiscal discipline, debt sustainability and economic policies before stepping in. A selloff driven by deteriorating French fundamentals would make intervention harder to justify for the ECB, and bleeding harder to stop.

Therefore, only a convincing fiscal agreement would bring relief to France and broader European markets. Continued political paralysis could keep investors on the sidelines, and the euro and European stock markets under pressure. For now, I would call this a worsening confidence shock. Whether it becomes a full-blown crisis depends on contagion – and on how policymakers respond.