Core bonds profit from weaker equities

Rates

Yesterday, core Bonds were helped by crumbling equities as investors sold stocks at the end of the quarter. EMU headline inflation was higher than last month but spot on expectations, while core inflation unexpectedly ticked lower. US eco data (Chicago PMI weak, consumer confidence strong) were mixed, but neither had a big impact. Hawks Lacker and George want to hike rates very soon (June) but their positions are known and they are part of the minority inside the FOMC. In a daily perspective, the German yield curve shifted 0.5 bps (2-yr) to 3 bps (30-yr) lower, flattening the curve. Changes on the US yield curve varied between -1.2 bps (2-yr) and +3.5 bps (5-yr), the belly slightly outperforming. On intra-EMU bond markets, 10-yr yield spreads versus Germany narrowed up to 5 bps with Greece once again underperforming (+52 bps). Greece is making investors nervous, very nervous.

Upward risks for EMU PMI, US ISM and ADP report

According to the preliminary estimate, the euro zone manufacturing PMI rose from 51.0 to 51.9 in March, after a stabilization in February. The outcome was above the market consensus of 51.5 and the final reading is forecast to confirm this figure. We believe that the risks remain for an upward surprise as also other business confidence indicators improved further during the month. After having dropped for four consecutive months, it will be interesting to see whether the manufacturing ISM shows signs of improvement in March. Regional indicators however continued to surprise on the downside of expectations and also the consensus is looking for a further weakening in business sentiment from 52.9 to 52.5. But also in the US, we see risks for an upward surprise as weather conditions have improved, port closures came to an end and the dollar weakened slightly in the last few weeks. The ADP employment report is expected to show a continuation of the recent trend. Private sector employment is forecast to have increased by 225 000 in March, following a 212 000 jump in February. Weather conditions were less poor and the early timing of Easter might be a positive factor. Therefore, we see risks for a stronger outcome.

Bobl auction should go well despite negative yield

The German Finanzagentur taps the on the run 5-yr Bobl (€4B 0% Apr2020). The bond didn’t cheapen in ASW-spread terms going into the auction. At the previous 4 Bobl auctions, total bids averaged €4.77B, though the last auction (February) clearly stood out (€6.47B). Since the ECB’s QE-announcement, German primary auctions started to go well despite record low yields. At the February auction the 5-yr auction yield was negative for the first time ever but that didn’t hamper demand.

Today’s Strategy

Overnight, Asian stocks trade mixed with China outperforming on the back of stronger PMI readings and Japan underperforming following a weaker (manufacturing) Tankan. The US Note future trades slightly off yesterday’s high, but it will most likely be the European equity market opening that determines the faith of the first trading hours of the Bund. In case of a bad opening (in line with Japan and US equity futures), lower European stocks could force a test of the contract high (159.13)/all-time low in yields (0.167%). The German 30-year yield set yesterday a minor new low.

Today, the eco calendar is interesting, especially in the US with ADP employment and manufacturing ISM. Risks for eco releases are tilted to the upside of expectations (see above). That’s a negative for US Treasuries, but the impact could be muted if the correction on stock markets continues.
Since the dovish FOMC-meeting, sentiment turned in favour of US Treasuries and stronger data this week will be necessary to allow US yields to recapture key levels (1.4% 5yr & 1.94% 10yr). If not, we could be heading to the cycle lows. Fed speakers include Williams (“midyear time to start lift-off debate”) and Lockhart (“June/July/September”) but both of them already spoke after the FOMC meeting.

In Europe, Greece remains a factor of uncertainty as talks on the reform list again prove to be very difficult. According to sources, the Euro Working Group could agree today by teleconference to approve the Greek list.
Overall, the technical picture for the Bund remains bullish. The current correction lower on equity markets underpins demand further, but we wouldn’t join the rally given very lofty levels. The ECB’s PSPP-programme should keep the upward potential of yields limited. The spread widening registered for Spanish and Italian bond yields is being reversez in recent days.