Core bonds close nearly unchanged in volatile session

Rates

On Wednesday, core bonds closed a volatile session nearly unchanged. Initial gains on rumours that 11 banks failed to pass the ECB AQR/stress tests were more than undone in the run-up to and after the US CPI release showed inflation stabilized in September (slightly above expectations). However, late in the US session, Treasuries recouped the losses as equities hit again the skids. Bunds had recouped losses already by the official closure of the European session. It is unclear whether the terror attack in Canada had anything to do with that move. The price action of core bonds once more underlined that bonds remain in favour of investors. The Bund kept above the uptrendline following a new test. Yield changes were less than 1 bp across the US and German curves. Peripheral and semi-core 10-yr yield spreads ended virtually unchanged, erasing some of the earlier narrowing in the final trading hour. Greece (-36 bps) and Portugal (-8 bps) outperformed. Volatility remains an issue.

The EMU eco calendar heats up today with the preliminary PMI’s for October and the first estimate of EU consumer confidence. In the US, initial jobless claims will be released and FHFA house prices. EU Leaders will start their two-day Summit.

The euro zone PMI’s are forecast to have weakened slightly further in October with the composite PMI expected to fall from 52.0 to 51.5, which if confirmed would be the third consecutive decline. The manufacturing PMI is forecast to drop from 50.3 to 49.9, below the 50 benchmark level, pointing to a contraction in activity. While the services PMI remains somewhat above the 50-level, a further easing is expected for October too, from 52.4 to 52.0. As forward looking indicators were poor last month and other indicators showed signs of worsening too, we believe that the outcome will be close to, maybe slightly below consensus. Consumer confidence for October is expected to have worsened too in October. The consensus is looking for a drop from -11.4 to -12, but also here we see risks for a weaker outcome. In the US, initial jobless claims dropped to a new cyclical low of 264 000 last week. For the week ending the 18th of October an increase to 281 000 is forecast. This week however included the Columbus Day holiday, which might cause extra volatility in the data. We believe therefore that another downward surprise is not excluded.

The E(M)U Summit of leaders start today. The first discussion themes will be energy, climate and Ebola. It will be interesting to see whether Europe can progress on structural reform. Indeed, the interconnectivity of energy distribution will take centre stage. Spain threatens to block the 2030 climate agenda. Spain wants to export its (green) electricity to France, but France refuses to connect the net with the aim to protect its nuclear industry. So, this may be an important test for the ability of Europe to advance its liberalization of the energy market. The economic and employment situation will figure on the agenda too. On Friday, an euro Summit takes place with again the difficult economic situation on the agenda. Mario Draghi will introduce the subject. Officially, the government finance figures are not on the agenda. Comments of participants might influence markets.

Overnight, most Asian equity indices are lower. Japan and China underperform despite better manufacturing PMI’s in both countries. WS’s weak trading session (slide following Ottawa shooting?) offers a possible explanation. The oil price slipped further as US government data showed an unexpectedly high level of inventories. The US Note future is nearly unchanged, indicating a neutral opening for the Bund.

Today, the eco calendar is interesting with EMU PMI data. A further slowdown is expected with the manufacturing PMI forecast to drop back below the 50-mark (boom/bust). Risks are slightly tilted to the downside. Such outcome is a positive for core bonds. Last week, global growth/deflation fears were one of the main reasons behind the increased volatility. Early October, the IMF estimated recession risk in EMU at 40% (deflation risk 30%). If the PMI drop below 50, headlines on a “triple dip” in Europe will be plentiful. In the US, weekly claims are scheduled for release. Sentiment on equity markets is the second factor to guide bond trading.
Core bonds profit from weak equity markets whereas this relationship isn’t very strong in the opposite direction. On intra-EMU bond markets, volatility increased as well of late. Risk-off sessions trigger large corrections higher. Cautiousness is warranted. The technical picture is still bullish for bonds. For the German Bund, the uptrend line since June was tested the past two sessions and provides support at 150.53 today. A break lower would be a first indication that the bull run slows. For the US Note future, attention could already start shifting to next week’s FOMC meeting (slower trading).