Volatile bond session leave core bonds little changed

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Volatile bond session leave core bonds little changed.

On global core bond markets, US treasuries rallied in the afternoon lifted by weaker US eco data and negative equity sentiment. The rally faltered, partly as equities fought back and partly as the second batch of US eco data positively surprised. Strange enough, the Bund remained stoical throughout the session despite increased currency and equity volatility. In a daily perspective, US yields were barely changed across the curve, while German yields fell between 0.3 and 2.7 bps, flattening the curve. On intra-EMU bond markets, risk-off sentiment led to a widening of spreads vis-à-vis Germany. Greece underperformed (+39 bps), while widening in Italy, Ireland and Spain was limited between 3 and 5 bps.

Today, the focus will be on the FOMC meeting. In December, the Fed was distinctly more hawkish than many expected. The FOMC was more upbeat on the labour market, while they could have expressed more concern about inflation than they effectively did. Finally, they tweaked their forward guidance. They no longer anticipate “that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time. Now, the Committee judges that it can be patient in beginning to normalize its stance of policy.

In the meantime, the labour market steamed ahead. We don’t expect a change to “household spending is rising moderately” either, despite the weak December retail sales (1st weak reading). On top, January consumer confidence boomed.
Business fixed investment could be downplayed following another weak orders and shipment report. The overall assessment should still be that economic activity is expanding at moderate pace.

Three issues may dominate discussions. First inflation dropped sharply in December (0.8% Y/Y from 1.3% Y/Y; mainly energy which the Fed considers a positive supply shock). Core CPI was marginally weaker at 1.6% Y/Y from 1.7% Y/Y. Nothing to get worried about. More contentious were the weak AHE in December (-0.2% M/M) and the downward revision to 0.2% M/M of the November figure. Also inflation expectations dropped quite substantially. So, on inflation the FOMC statement might be more dovish. Doves will argue that absence of wage pressure and low inflation (expectations) point to the need of a delay in the lift-off. A second issue is the stronger USD and the situation outside the US. We don’t expect a reference to the strong USD in the statement, but if it would, it’s a dovish signal. The economy outside the US is probably still considered weak, but not materially different from December. EMU QE is a final issue. Reason enough to delay a lift-off or an argument to go faster (less slump in the EMU economy)? These issues could trigger important changes to the statement, but we think the Fed will stick to the view that they can be patient in normalizing policy further (ie unchanged in March/April). Time is on their side. Our scenario remains a June lift-off. Markets are more dovish (Jan2016).

Today, the German Finanzagentur taps the on the run 30-yr Bund (€2B 2.5% Aug2046). In the run-up to the auction, the bond underperformed against the rest of the longer-dated German bonds, because it doesn’t fall under the scope of the ECB’s QE-programme with its 31-year maturity. Starting in March, the ECB will buy sovereign debt with maturities ranging between 2 and 30 years. Last year, total bids averaged €1.94B at 30-yr Bund auctions. Today’s auction will be difficult anyway with a record low yield, just north of 1%. In the US, the Treasury holds a $26B 2-yr Note auction and a $15B 2-yr floating rate note auction.

Overnight, Asian equities opened on a weaker footing, but managed to reverse opening losses. Chinese stocks underperform though. Very impressive Apple earnings and unexpected easing by the Monetary Authority of Singapore lifted stocks. The US Note future trades stable overnight, suggesting a neutral opening for the Bund.

Today, the eco calendar is empty apart from the FOMC meeting. We expect Yellen to hold the line that the Fed “can be patient” in deciding when to hike rates, indicating unchanged policy at the next two meetings (March & April). Rate markets don’t buy the Fed’s rate projections and expectations of a first hike this Summer. Therefore, if the Fed doesn’t put additional weight to the recent decline in inflation or rise of the dollar, a slightly hawkish reaction can be possible (higher US rates). Sentiment on equity markets remains a driver for core bonds as well. Yesterday, the correlation was especially high between US Treasuries and US equities. Strange enough, for the first time the Bund couldn’t profit from risk-off sentiment. Finally, Greece is a wildcard with the new Syriza-led coalition on collision course with Europe. Greek assets are expected to continue to underperform.

Longer term, oonce the ECB QE-programme begins, flows will play a very important role on EMU bond markets and will likely act as a key constraining influence on upward potential of most EMU bond yields.