IFO might surprise on the upside

Rates

Yesterday, global core bonds ended mixed. German bonds ended close to unchanged as calm returned to markets following recent hectic sessions. The rouble found its composure, oil only marginally declined (in the end you get used to anything) and European equities stabilized. Changes on the German yield curve ranged between -1 bp (2-yr) and +0.6 bps (30-yr). US Treasuries were significantly lower, but that had everything to do with the timing of the Fed meeting (after European closure). We conclude that the Fed stays on course with its normalization process, but via their new forward guidance of “patient” there was no sign whatsoever that the pace by which it advanced has fasten one inch. For a full review, see our flash report. At the end of the session US yields were 3.7 bps (30-yr) to 9.6 bps (5-yr) higher.

On intra-EMU bond markets, 10-yr yield spreads versus Germany narrowed up to 6 bps with Greece outperforming (-30 bps). However, after European trading the results of the first Greek presidential vote came out. PM Samaras’ candidate was backed by 160 members of parliament, well short of the 200 votes needed and at the lower end of the 160-165 votes expected. This doesn’t bode well for the second presidential vote (Dec 23; 200 votes needed) and the third vote (Dec 29; 180 votes needed). Under Greece’s constitution, if PM Samaras fails to get necessary support for this candidate by then, Parliament would be dissolved and snap election called (February). Currently anti-austerity party Syriza (calls for more haircuts) still leads in the opinion polls but their lead is narrowing. We believe that the disappointing outcome of yesterday’s vote could again trigger weakness in Greek assets with contagion to other PIIGS likely limited.

Today, the eco calendar contains the German IFO business climate indicator, US jobless claims and Philadelphia Fed index. EU leaders will start their two-day Summit in Brussels and Spain (Obligacion) and the US (5Yr TIPS) tap the market.

In November, the German IFO business climate indicator picked up unexpectedly, ending its downtrend that was in place for already six months. Today, it will be interesting to see whether the rebound will be confirmed. The consensus is looking for an increase from 104.7 to 105.5 in December. After a better than expected manufacturing PMI and a further improvement in the ZEW, we believe that also the IFO might surprise on the upside, supported by lower oil prices. In the US, initial jobless claims are forecast to stay broadly unchanged in the week ending the 13th of December. The consensus is looking for a slight uptick from 294 000 to 295 000. We believe that the risks are for a lower outcome as claims are still somewhat above the levels seen in the previous months, probably due to large swings in the seasonal adjustment factors around the end of the year. The Philadelphia Fed index showed a remarkable jump in November, from 20.7 to 40.8, the highest level in more than 20 years. The November figure might have been an exaggeration and therefore a drop is expected for December, to 26.0. We have no reasons to distance ourselves from the consensus.

In an interview with the WSJ, ECB Coeuré gave one of the clearest hints to date that the ECB is readying more stimulus to raise inflation and boost the economy: “I see a broad consensus around the table in the governing council that we need to do more”. More in particular, a sovereign bond buying programme seems the preferred option: “It’s not that much of a question on whether we should do something, but more a discussion on the best way to do it. If we want to do more, we obviously have to reach out to market segments where there is more liquidity, and that is why the government bond market is the baseline option, which doesn’t necessarily mean we would only buy government bonds.” On the timing of more easing, he was vague but didn’t rule out a January move: “Ideally you would need enough time to assess what exactly is the pass-through from lower oil prices to core inflation and to know more about the second-round effects. On the other hand, we don’t want to be behind the curve and act too late.”

Overnight, most Asian equity markets trade with gains copying WS strength after the FOMC with Japan outperforming. The US Note future is slightly off the overnight lows but trades stable.

Today, the eco calendar contains German Ifo and US claims & Philly Fed. We see risks for a better Ifo but this is unlikely to have a lasting impact on European bond markets with the ECB on the brink of additional easing (see eg Coeuré comments higher). Risks for US data are on the downside of expectations but also here we don’t expect an enduring effect on markets with the FOMC meeting in mind. Yellen & co made clear that they are still set for a (Summer) 2015 rate hike. Very short-term safe haven flows might still dominate in case the crash in EM FX/oil/equities continues but longer term this is a negative for US treasuries with underperformance of the front end of the curve (2-5yr). For German rates, we expect only small spill-over effects from eventual higher US rates. At least until the day that the ECB effectively walks the QE talk, we think there is very little upward potential in yields. For intra-EMU bond markets, contagion risks (Greek political gamble, higher volatility) increased which could lead to some spread widening (PIIGS) despite an anticipated sovereign QE-programme.