Bund stabilizes, but US Treasuries outperform again

Rates

Global core bonds parted ways yesterday. German Bunds were under pressure in the morning session. Supply in France, Spain and Italy that carried over into the Bund market probably weighed together with higher UK yields after strong retail sales. Illiquidity magnified the move. Slightly weaker PMI’s and EMU consumer confidence played no significant role. Peripheral yield spreads were 3 to 4 bps lower with Greece the exception (+6 bps). During US trading, the Bund gradually erased earlier losses, leaving yields up to 10-year within 1 bps from Wednesday’s close. The 30-year German yield was up 2 bps.

US Treasuries on the contrary had another fruitful session and closed the day with yields 1 to 5.9 bps lower, the curve flatter. The US-German 10-year yield spread has dropped 15 bps in 2 days, after a 20 bps widening in the three previous sessions. A small increase in US initial claims set the stage for some short covering. The mid-morning data (Philly Fed and Existing Home sales ) were a bit weaker helping US Treasuries to sustain the rally. Treasuries topped out, but held steady at intra-day highs with moderate gains.

US CPI, the EMU Summit and CB talk key items today

In contrast to the PMI’s, the German IFO business climate indicator extended its improvement in April, although the expectations sub-index lost some ground. For May however, the consensus is looking for a limited decline in the headline figure from 108.6 to 108.3. We believe that the risks are for a weaker outcome as business sentiment in Germany seems to have weakened somewhat and also the strikes might have weighed on sentiment. In the US, headline CPI inflation remains stubbornly low and even a further drop is expected for April. The consensus is looking for a slowdown in the annual rate of inflation from -0.1% Y/Y to -0.2% Y/Y, while on a monthly basis, CPI is expected to have risen by 0.1% M/M. PPI surprised on the downside and also the early timing of Easter might have limited price increases in April. Therefore we believe that the risks are for a downward surprise. We also see downside risks for core CPI.

Regarding the EU Summit, we don’t expect a breakthrough in the Greek conundrum. Talks between the main players overnight apparently didn’t progress the process. Tsipras talks today with Juncker, but he doesn’t look the key player on the subject. Fed Chairwoman Yellen will speak about the economy (no Q&A). Markets will compare her comments to the remarks in the Minutes. However, she speaks after cash bond markets are closed (early close ahead of Memorial Day) and it doesn’t seem the right timing to convey new info to the markets. ECB’s Draghi speaks in Portugal. We don’t expect him to announce new measures or give markets new impetus, as the broad ECB policy for the next months (Sep 2016) is in place. However, it is certainly a wildcard and he may elaborate on recent Coeuré comments or market volatility.

Today: Some upward pressure on yields, but no break

Overnight, Asian stock markets trade positive with Chinese equities still sharply outperforming. Japanese equities are nearly flat as the yen strengthens for second day. BOJ was optimistic on growth. The Reuters monthly Tankan was encouraging, too. The dollar trades somewhat weaker across the board, while the T-note future is little changed.

Today, the eco calendar contains the IFO and US CPI. We see downside risks for both (see higher). That should be positive for bonds, even as the reaction on the IFO may be muted, as a weaker German PMI was released yesterday. Lower US (core) CPI may be of bigger importance (positive) for US Treasuries as it might have central bank implications. However, markets have already left the idea of a June (and September) rate hike. So, the reaction (negative) might be greater should CPI and core CPI come out higher (which isn’t our expectation). The Bund may profit from a rise of US Treasuries, even if the correlation has weakened. The long weekend and the early close today are also usually positive features for core bonds. The EU Summit and CB speakers are wildcards, but will likely pass without too much fuss.

The Bund stabilized in recent sessions following the sell-off, but there is no firm signal that the sell-off is over yet. A move above 154.97 (38% retracement) would make the picture more bullish, but seems today out of reach. The downside looks protected too with the 151.44 sell-off low as line in the sand. So, more consolidation is our favourite.

The US T-Note is in a sideways range with boundaries at 128-04+/12 and 126. A test of the upside is possible but unlikely to succeed today.