Risks for EMU data are on the upside of expectations

Rates

Big week for EMU (QE) and US (payrolls)

On Friday, global core bond trading showed two faces. Downward pressure ahead of European noon was reversed afterwards. We retain that German inflation was significantly higher than expected but unable to leave a permanent trace on markets. Fed comments (see below) had no lasting impact either. At the end of the session, the German yield curve bear steepened with yields 0.7 bps (2-yr) to 4.5 bps (30-yr) higher. Changes on the US yield curve varied between -2.8 bps (2-yr) and -3.9 bps (30-yr). The big difference in yield terms was mainly due to a catch-up move at the start of European trading. On intra-EMU bond markets, Greece underperformed (+16 bps) as potential short term funding problems trump the fact that the German Bundestag backed the Greek bailout extension.

The eco calendar is well-filled today. In the euro zone, the first estimate of February HICP inflation is forecast to show a limited pick-up, from -0.6% Y/Y to -0.5% Y/Y. On Friday however, not only German, but also Spanish and Italian inflation came out substantially higher than expected and we believe that also euro area inflation will surprise on the upside of expectations. The core reading is expected to stay unchanged at its record low level of 0.6% Y/Y. Also here, we believe that the risks are for an upward surprise. The EMU unemployment rate is expected to stay unchanged at 11.4% in January. The risks, if there are any, remain for a downside surprise. Finally in the euro area, also the final reading of the EMU manufacturing PMI for February will be released. The first estimate showed only a marginal increase from 51.0 to 51.1, but also here, we believe that the risks are for an upward revision, supported by easing tensions around Greece. In the US, the manufacturing ISM is expected to decline for a fourth consecutive month. The consensus is looking for a limited drop from 53.5 to 53.2. Although the index has weakened already significantly, we continue to see downside risks, especially due to poor weather conditions and supply chain issues related to the labour dispute in the West Coast ports. Personal income and spending are forecast to remain mixed. Income is expected to have risen by 0.4% M/M in January, while spending should have dropped for a second straight month. Also the core PCE will be interesting after last week’s stronger than expected core CPI. An upward surprise won’t pass unnoticed.

Two centrist heavy-weight Fed members spoke later on Friday: NY Fed Dudley and Fed chairman Fischer. Dudley holds his view that “risks of lifting the federal funds rate off the zero lower bound a bit early are higher than the risks of lifting off a bit late”. While he sees no urgency to raise rates, he added that unusually low bond yields could force the Fed to act more aggressively once it starts tightening policy. Fischer was somewhat more hawkish: “the FOMC and market participants anticipate that the federal funds rate will be raised sometime this year.” More specifically, he acknowledged broad-based expectations that the Fed raises either in June or September and that a discussion is going on about dropping “patient” from its guidance.

Eurogroup President Dijsselbloem said that Ministers of Finance were prepared to make a first disbursement of the remaining €7.2B loan tranche as early as this month. Therefore Greece must immediately start adopting some of the economic reforms agreed on under the 4-month bailout extension. In March, Greece faces a €1.4B IMF repayment, but risks of a cash crunch loom.

Overnight, Asian stocks trade mostly positive with China outperforming as the PBOC cut its policy rates by 25 bps during the weekend. At the same time however, they raised the upper band of bank deposit rates from 1.2x benchmark rates to 1.3x. This dampens the overall impact of the monetary easing. Chinese PMI’s reported over the weekend and this morning surprised on the upside of expectations. The US Note future is only marginally lower, suggesting a neutral opening for the Bund.

Today’s eco calendar is interesting. Risks for EMU data are on the upside of expectations (EMU CPI & final figure PMI). However, we don’t expect much reaction ahead of Thursday’s ECB meeting. The technical picture remains bullish. ECB purchases should limit upward potential in EMU bond yields.
In the US, risks to the manufacturing ISM remain on the downside of expectations. However, the core PCE reading will grab most attention. An upward surprise, like last week’s core CPI, won’t pass unnoticed and might push the US Note future lower in the 126-12 to 128-04+ trading range! All in all, the market reaction to the data should be symmetrical with upward pressure in case of weaker numbers and vice versa. Technically, we expect the mentioned sideways range to hold going into the payrolls. Longer term, we hold our June rate hike call and think there is more downside in the Note future as markets are positioned more dovish.