Euro zone PPI data for August are quite outdated for markets

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Yesterday, global core bonds surprisingly surged higher as the fear factor came back with a vengeance. It started only around noon CET. Various factors might have been in play. Renewed fighting in Eastern Ukraine, political uncertainty in HK, talk about more sanctions on Russia, the first Ebola case in the US and weaker business surveys in the manufacturing sector. The risk-off ball gradually got more speed and bonds went from strong to stronger as investors flocked to the safe havens. The Bund set a new contract high (150.42) and the 10-year German yields approached the all-time lows. The US yield curve bull flattened with changes ranging from 5 to 10.5 bps. The German curve flattened too in a bull fashion with yields down 0.4 bps (2-yr) to 4.6 bps 30-yr. The weak German 10-yr auction was fast digested. To our surprise, peripheral bonds managed to match (Italy) or even outperform (Spain, Portugal & Greece) core bonds. In the case of Greece, it follows a sharp sell-off.

After EMU CPI inflation data for September, the euro zone PPI data for August are quite outdated for markets, although they might be interesting. PPI is forecast to have dropped further to -1.2% Y/Y from -1.1% Y/Y in July. Recently there were signs that EMU PPI was starting to pick up, but we believe that PPI inflation might drop again due to the recent decline in oil & commodity prices.
In the US, initial jobless claims are forecast to have edged up slightly. The consensus is looking for an increase by 4 000 to 297 000. We believe that claims will remain close to the 300 000 level and have therefore no reasons to expect a material change from the consensus. US factory orders will remain volatile due to the swings in Boeing orders. After a 10.5% M/M increase in July, a decline by 9.5% M/M is expected. Most is already known from the durables report.

We don’t expect the ECB to announce new measures today (see flash report for full coverage). The market focus will be on the details of the ABS and the covered bond buying programs. These are important for their success for the impact on the ECB’s balance sheet expension. Draghi suggested that the BS may expand over time to €3Tr. We think this is highly unlikely with the TLROs and the ABS/CB purchases alone , leaving the room for an eventual new, full blown QE-programme (sovereign bonds). However, it is clear that such a program is still hitting a lot of resistance. Should the ECB decide to buy also lower-rated Greek and Cypriot ABS (cf. FT article), markets may consider it as a further step towards QE (sov. bonds). However, chances of this happening are probably small. We suspect Draghi to sound very dovish and keep the option of more purchases open.

More in particular, markets will listen closely to comments on the buying of mezzanine tranches (in ABS), the appreciation of the (disappointing) first TLTRO, the recent drop in core inflation and weak surveys.

Spain and France tap the market. The Spanish treasury taps the on the run 5-r Bono (1.4% Jan2020) and on the run 10-yr Obligacion (2.75% Oct2024) for a combined €2.5-3.5B. The relatively low amount on offer should be easy to digest for investors. The bonds didn’t cheapen into the auction as the recent underperformance on the Catalonia referendum has already been undone. On the curve, the 5-yr Bono trades normal whereas the 10-yr Obligacion is rather rich. The French debt agency sells the off the run 10-yr OAT (1.75% May2023), the on the run 10-yr OAT (1.75% Nov2024) and the off the run 15-yr OAT (2.75% Oct2027) for a combined €7-8B. These bonds didn’t cheapen ahead of the auction neither. Both off the run OAT’s trade a little rich but we don’t expect that to impact the auction. French auctions tend to go well.

Overnight, Asian equity markets reflect yesterday’s sour sentiment in Europe/US. Japan underperforms on yen strength. China and Hong Kong are closed. The US Note future steadied after yesterday’s impressive run higher.

Today, all eyes are on the ECB where president Draghi unravels the details of his ABS and covered bond buying programmes. We think those details will be put against Draghi’s vow to increase the ECB’s balance sheet by €1000B. Because of multiple constraints (see our FLASH), there are risks of disappointment (not enough to fuel growth and inflation) and a cry for sovereign bond buying. The latter is something Draghi won’t deliver right now. Combined with the usual softness on the press conference, these are supportive elements for the Bund. In yield terms, the 10-yr yield can test the 0.86% record low.

We believed that the divide between EMU and US would magnify this week. The EMU side of the story proved correct with lower inflation and a grim eco picture (and dovish ECB today). On the US side, we were taken by surprise by the deterioration of risk sentiment on equity markets because of several small factors (see above). This drove safe haven flows and eco data played second instead of first fiddle. The US Note future is back above 125, opening the path to the highs. In yield terms, we are back below 2.50%/2.46% support. We await the outcome of the ECB meeting, but especially payrolls to re-evaluate our main view that the ongoing US recovery and normalization of Fed policy are at the moment key driver for US bond markets.