Soft Draghi pushes Bund mildly higher

Rates

Yesterday, German bonds profited modestly from a very dovish ECB President Draghi, following a largely sideways to slightly upwards oriented journey ahead of the ECB meeting (see flash for extensive coverage). The ECB effect was stronger in other markets where EMU equities eked out good gains and the euro tumbled lower (see FX section). Oil erased initial gains as did US equities.

Draghi stressed the ECB’s willingness, readiness and capacity to act if necessary. He added that the ECB would fully implement the existing QE-programme and may extend it beyond September 2016 if necessary. The ECB significantly downgraded growth and inflation forecasts. Draghi expects that it will take longer to reach the 2% inflation target and stresses downside risks for both growth and inflation forecasts. We feel vindicated by our call that additional easing will be forthcoming, likely around the turn of the year. The ECB thought it was still premature to judge the impact of recent EM and market developments on EMU growth/inflation and preferred to stay side-lined for now. The Bund profited at the start of the press conference on the soft talk, but could only build out some additional gains in after trading. Investors are clearly reluctant be short rates going into the payrolls and the FOMC meeting. In a daily perspective, German yields dropped by up to 5.8 bps, the belly outperforming the wings. In the US, the Non-manufacturing ISM fell less than expected to a still very high 59. US Treasuries initially fell back, before rallying higher when US equities erased gains. They still underperformed German Bunds with US yields up to 2.6 bps lower. On EMU bond markets, spread narrowing was small with Portugal (-5.6 bps) and Greece (-22.5 bps) outperforming.

Attention for US payrolls and G-20 meeting

In July, US non-farm payrolls increased by 215 000, in line with the recent trend. The details remained robust too, although wage growth continued to lag. For August, a similar report is expected with the consensus looking for a payrolls increase by 217 000. Business surveys weakened slightly from July, while jobless claims remained in line with the recent trend. The ADP report showed a slight pick-up in private sector hiring, but also remains in line with recent trends. Overall, the risks are for a slightly lower outcome, but we expect the recent trend of strong job growth to continue, keeping the door open for a rate hike in September. In the previous years, the first estimate of August payrolls usually surprised on the downside, but was followed by upward revisions afterwards, a pattern that might continue this year. The unemployment rate is expected to extend its downward trend in August, falling from 5.3% to 5.2% and entering the Fed’s target range of maximum sustainable employment (5.0% to 5.2%). We have no reasons to distance ourselves from the consensus. Also wage data will be closely watched. Average hourly earnings are forecast to have increased by 0.2% M/M, keeping the annual rate unchanged at 2.1% Y/Y.

Today: Can payrolls seal the deal for September liftoff?

Overnight, risk sentiment deteriorated further in Asia following late session weakness on WS. There is however no additional risk-off factor. Japanese stocks underperform following disappointing wage data. The US Note future extends its gains, suggesting a positive opening for the Bund as well.

Today, all eyes are on the payrolls report. Ahead of the release, trading will likely be calm. The consensus expects 219 000 job growth with risks slightly tilted to the downside of expectations. We believe that anything but a big miss (>50k) raises chances of a September lift-off to very likely. Apart from the headline number, also the unemployment rate and wage data will be closely monitored. Such decent outcome should weigh especially on the front end of the US yield curve with a flattening effect. The impact at the longer end of the curve is less straight-forward. Risk-off sentiment, the US long weekend ahead, a possible lowering of the median Fed dot for the longer run (3.75% to 3.50%) and (for Europe) the elevated chance of additional easing around the turn of the year could offset potential losses from decent/strong payrolls.

Technically, we expect the recent highs in the Bund (156.49) and US Note future (129-10+, Dec. Contract!!) to hold, even if equity and/or commodity markets suffer. We have a sell-on-up ticks approach for the Bund and US Note future, preferably near the highs.