Global core bonds slid lower well into the US session

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Yesterday, global core bonds slid lower well into the US session. Apart from mixed US housing data (housing starts & building permits), the eco calendar was empty. Central bank speakers didn’t provide input either. The decline was possibly be due to anticipation on hawkish FOMC Minutes and stronger PMI’s today. The Minutes eventually were a non-event. The US Note future initially spiked higher as the Minutes sounded a bit softer on inflation than the statement. FOMC members noted the stable "survey-based" inflation expectations and the fall in energy prices, but they still expected inflation will rise back toward the 2% area in the coming years. However, "a few” were concerned that lower inflation would persist "for quite some time," and "many participants" felt the need to watch for "a possible downward shift in longerterm inflation expectations," noting that "would be even more worrisome if growth faltered." However, markets rapidly recovered as the rest of the statement reflected the hawkish shift made in October. Going forward, there were no hints whatsoever on scrapping the “considerable time” phrase from the statement. The discussion on the topic shows an even balance of supporters and opponents. At the end of the session, the US yield curve moved 1.6 bps (2-yr) to 4.4 bps (10-yr) higher. Changes on the German yield curve varied between +1.4 bps (2-yr) and +5.2 bps (10-yr).

Today, the eco calendar is heavy with PMI’s and consumer confidence in EMU and CPI figures, weekly claims and Philly Fed indicator in the US. In EMU, consensus expects a small uptick for the preliminary readings of both the manufacturing PMI (50.6 to 50.8) and services PMI (52.3 to 52.4). We believe that risks are slightly tilted to the upside of expectations as recent European indicators showed that investors/markets might be painting a too grim picture of the economy. In the US, October CPI is expected to show a small decline from 1.7% y/y to 1.6% y/y. The core reading is expected to stabilize at 1.7% y/y. We think risks are balanced. On the one hand, we had higher PPI data earlier this week. On the other hand, price components of some regional confidence indicators showed a significant drop. Apart from that drop, regional confidence data continued to print at strong levels, which could as well be the case for today’s Philly Fed indicator (decline from 20.7 to 18.5 expected).

Today, the Spanish treasury sells the on the run 3-yr Bono (0.5% Oct2017), the on the run 5-yr Bono (1.4% Jan2020) and the off the run 30-yr Obligacion (4.7% Jul2041) for a combined €2-3B. That’s a relatively low amount. The bonds didn’t cheapen going into the auction. Both the Jan2020 and the Jul2041 trade a tad rich on the Spanish yield curve. Overall, we expect that the auction will go well. The prospect of outright QE by the ECB, the constructive Spanish stress tests results and signals that the Spanish recovery is gaining traction are positive elements. The French debt agency taps the off the run 5-yr BTAN’s (1.75% Feb2017 & 1% Jul2017) and the on the run 5-yr BTAN (0.5% Nov2019) for a combined €6.5-7.5B. Bonds on offer traded stable into the auction. As usual, we don’t expect difficulties from the French taps. Additionally, France will try to raise €0.8-1.3B via inflation-linked bonds.

Overnight, Asian equities trade mixed. Japanese eco data were mixed while the Chinese HSBC flash manufacturing PMI fell from 50.4 to 50. The US Note future trades marginally higher, but we don’t expect a big impact for the Bund opening.

Today, the eco calendar heats up. Two releases draw our attention. First, the EMU PMI’s. We see risks slightly tilted for a stronger outcome which could slightly weigh on the Bund and signal that also the upper bound of the 149.91/152.49 sideways range is well protected. In the US, CPI data are the next big thing. Yesterday’s Minutes showed somewhat more concerns on the risks of too low inflation compared with the October FOMC statement. Inflation could be the missing link where markets are waiting for before placing new bets on an earlier Fed rate hike. The market reaction should therefore be clear: higher US Note future in case of miss, lower US Note future in case of an upward surprise. Fed Mester’s speech on forward guidance is a wildcard for trading.

The FOMC changed its forward guidance to include the data-dependence of the lift-off date. We argued that US Treasuries would become more sensitive to US eco data.. We are disappointed in the market reaction until now but our main view remains that the FOMC verdict opened the way for a new downleg of US Treasuries (125-27 1st support), especially if accompanied by stronger data. Any spill-over from higher rates to Europe will be very limited, with the ECB clearly studying the option to ease policy further. The downside in the Bund seems well protected (149.91 first support). Sideways trading between that support and the contract high (152.49) is likely.