Today's focus to remain on Europe data

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Yesterday, US markets were closed for Thanksgiving. In Europe, both equities and bonds rallied further. There were plenty of eco data, which painted a mixed picture. We retain that the German CPI dropped from 0.7% Y/Y to 0.5% Y/Y, but in line with expectations. Low inflation, low growth and dovish central bankers keep ECB QE bets alive. In this technically inspired trading session, the German 10-yr yield tested the previous record low with a new dip to 0.70%. At the end of the session, the curve bull flattened with 2-yr yields 0.2 bps higher but all other maturities lower up to the 4.1 bps (30-yr). On intra-EMU bond markets, peripheral bonds rallied further with 10-yr yield spreads 1 to 7 bps tighter.
Greece underperforms (+15 bps). Greek markets are recently under pressure because of concerns over an early election next year and difficult talks between Greece and the Troika on winding up the bailout programme. If Greece really wants to exit and replace the remainder of the programme by a precautionary credit line, they need an agreement by the final Eurogroup meeting (Dec 8).

Although US markets are open on Black Friday, desks will probably be thinly staffed and also the eco calendar is empty. In the euro zone, the unemployment rate and the first estimate of HICP inflation for November will be released. ECB’s Costa and Weidmann are scheduled to speak.

In the euro zone, inflation is forecast to have slowed again in November. The annual rate of inflation is forecast to drop again to its cyclical low of 0.3% Y/Y from 0.4% Y/Y in October. Yesterday, German inflation dropped from 0.7% Y/Y to 0.5% Y/Y and also Belgian and Spanish inflation declined further into negative territory. We believe that also for the euro area reading, the risks are for a lower outcome. Core inflation is projected to stay unchanged at 0.7% Y/Y as downward price pressures were probably mainly based in energy. The unemployment rate is projected to stay unchanged at 11.5%, which if confirmed would be the fifth consecutive month. For the unemployment rate, we believe that the risks are for a lower outcome too.

Overnight, Asian equities trade mostly in positive territory. Japanese inflation was slightly softer than expected and so were retail sales, supporting the case for monetary stimulus. The decline in the oil price is supportive for Japanese equities and for the USD (/JPY). For now, there is no obvious reason to expect a U-turn in the ECB QE trade despite the impressive rally over the previous days.

Today, the focus remains on Europe. In the US, trading will remain thin because of “Black Friday” (early close). There are also no US data on the agenda. In Europe, CPI is expected to decline to 0.3% Y/Y, matching the lows from August/September. We think that the scope for any market reaction in the Bund is small after extremely dovish ECB comments recently and given that the German yield curve trades at record low levels (yesterday 10-yr yield 0.70%). Or will we get a final exhaustion move? Technically, the Bund is in overbought conditions.

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. Since that meeting, US rates were relatively stable in a thin sideways range. Wednesday’s technical breaks on the downside (in yield terms), despite stronger US eco data the past month, are an important warning signal. Is it because markets doubt the Fed? Or because they fear a that disinflation will transit to the US? Or because investors find the yield pick-up at the long end of the US curve attractive in the current environment? Whatever the reason, a confirmed break below 1.55% (5-yr), 2.27% (10-yr) and 3% (30-yr) would suggest that yields could drop further short term even though it feels completely unnatural given the Fed’s stance.