Bonds sold off once risk sentiment turned positive
Rates
On Friday, European bonds started strong, catching up with US Treasuries.
However, sentiment on risk improved fast, allowing equities to gradually erase early losses. German bonds initially slid into a sideways trading mode, but more strength in US equities was the straw that broke the camel’s back, triggering outright bond selling. It pushed US Treasuries well into the red and eliminated early German bond gains. The trigger for the turn in the sentiment on risk was reports that the terms for the Deutsche Bank settlement would be much better than the $14B earlier spoken about. The decline in oil prices in the morning session may still have restraint core bonds losses, but the recovery in the afternoon session helped equities to rebound further even it occurred largely ahead of the core bond selling. In a daily perspective, the US yield curve bear steepened with yields 2.8 bps (2 yr) to 3.9 bps (30-yr) higher. The German yield curve, which had to play still catching up with the US Treasuries ended narrowly mixed with yields up 0.2 (2-5-yr) and down 0.3-0.4 bps at the 10-yr tenor and beyond. On intra-EMU bond markets, the initial sharp spread widening attracted bargain hunters once the risk sentiment improved. Spanish and Italian 10-yr yield spreads fell still 4 and 2 bps, while Greece and Portugal were 2 bps wider.
Manufacturing confidence in focus today
In August, the US ISM manufacturing confidence index fell unexpectedly to 49.4 from 52.6 in July. It was the first month below the 50 boom/bust level since February 2016. For September, an improvement to 50.2 is expected. The regional surveys were mixed, but mostly slightly better than expected. Our projection is for a rise to 50.6, slightly above the consensus. The EMU manufacturing PMI rose unexpectedly in September (52.6) while the Caixin and National PMI’s stabilized just above 50. So, we see risks for an above consensus outcome, but the index should only slightly exceed the 50 threshold, suggesting the manufacturing sector continues to struggle as the global economic motor shows little signs of an acceleration. The final EMU manufacturing PMI is expected to have remained unchanged compared to the preliminary one (52.6). Of course also the UK, Canadian and many other, smaller countries publish their PMI’s, which might affect the local markets. Later this week, the US payrolls on Friday will as ever be the eye-catcher.
Germany, France and Spain tap market
This week’s scheduled EMU bond supply is rather low, with only Germany, France and Spain tapping the market. On Wednesday, the German Finanzagentur auctions the 10-yr on the run Bund (€4B 0% Aug2026). On Thursday, the French debt agency sells the on the run 10-yr OAT (0.25% Nov2026), 15-yr OAT (1.5% Mar2031) and 50-yr OAT (1.75% May2066) for a combined €6.5-7.5B. The Spanish Treasury taps the on the run 5-yr Bono (0.75% Jul2021), 10-yr Obligacion (1.3% Oct2026) and the off the run 30-yr Obligacion (4.2% Jan2037). The amount on offer still needs to be announced. This week’s auctions won’t be supported by bond redemptions.
Stronger ISM negative for Treasuries, but more to come?
Overnight, Asian stock markets gain ground in line with Deutsche Bank’s and WS’s revival on Friday. China and South Korea are closed for holidays. The US Note future and Brent crude trade stable, suggesting a neutral opening for the Bund.
The main item on today’s eco calendar is the US manufacturing ISM. Risks are on the upside of expectations, which is slightly negative for US Treasuries especially if dust settles on last week’s financial sector concerns. They could influence Fed rate hike expectations. Currently, the market implied probability of a Fed rate hike is 17% in November and 59% in December. Some investors might remain side-lined with other major eco releases (US non-manufacturing ISM, ADP, payrolls) ahead this week. On intra-EMU bond markets, Spanish bonds could outperform following the resignation of Socialist party leader Sanchez. This raises chances that some socialist MP’s abstain if PM Rajoy makes another bid with his proposed minority government ahead of the Oct. 31 deadline.
Technically, the Bund broke above the upper bound of the post-Brexit trading range (163-165.63). The break wasn’t confirmed by a move of the German 10-yr yield below -0.20%, making it less relevant. The trading range for the US Note future is expected to be 130-01+ to 132-05. Depending on the outcome of this week’s eco data, a test of one of these boundaries could occur.
Author
KBC Market Research Desk
KBC Bank
