US ISM manufacturing confidence eye-catcher

Rates

Quiet bond session ends with a rout, as oil jumps higher

Global core bonds had initially a very quiet session ignoring eco data, weaker equities and Jackson Hole comments. In late European trading, Bunds and US Treasuries started sliding again and soon tumbled substantially lower. The trigger might have been another steep jump of crude oil. Brent went from $48/barrel to more than $53/barrel in a few hours, following already steep increases last week. Two factors may have triggered the oil short squeeze. The EIA said production had been lower than recently assumed and OPEC said it is open to talk amongst producers aiming a fair price. Core bonds got a rude awakening and fell sharply. In the case of German bonds, the decline continued after the official close, as witnessed by the 100+ ticks decline in the Bund. Given the low volumes traded we would be cautious interpreting the size of the moves.

In a daily perspective, the German yield curve bear steepened with yields up to 7.4 bps higher. The US yield curve also steepened but yields were 2 to 4.3 bps higher. The US 2-year yield at 0.73% tests the highs, as higher oil prices may raise chances on a September lift-off. On intra-EMU bond markets, 10-yr yield spreads versus Germany were little changed. Greek bonds didn’t suffer from the first election polls published this weekend. They show a narrow lead for SYRIZA (+2% vs +15% in May), opening up the possibility of messy coalition talks.

US ISM manufacturing confidence eye-catcher

Today, the eco calendar contains the EMU (final) manufacturing PMI and unemployment rate, while in the US, the manufacturing ISM will be released. According to the preliminary estimate, the EMU manufacturing PMI stayed unchanged at 52.4, beating the market consensus which was looking for a limited decline. The final reading is forecast to confirm this outcome. We believe that the risks are for an upward surprise, as other indicators were mostly somewhat stronger and we believe that Chinese tensions probably had no meaningful impact on the final manufacturing PMI. Also in the EMU, the unemployment rate is expected to stay unchanged at 11.1%, which if confirmed would be the third straight month of stabilization. We believe however that the risks are for a limited drop in the unemployment rate.

Finally, in the US, the manufacturing ISM is expected to have stabilized at 52.9 in August following a significant drop in July. Regional indicators were mixed during the month, but hard data showed some signs of improvement. Following the significant drop in July, we believe therefore that the risks are for a limited rebound.

Sterling remains in the defensive

Sterling trading developed in thin market conditions yesterday as UK markets were closed for the summer Bank Holiday. The EUR/GBP pair initially hovered in the 0.7265/0.7300 area but sterling came again under pressure later in the US trading session. Remarkably, this setback occurred as oil rallied sharply at the same time. EUR/GBP closed the session at 0.7306 from 0.7268 on Friday. Cable initially hovered sideways in the lower part of the 1.54 big figure, but dropped back to just north of the key 1.5330 area. However, a break didn’t occur.

Today, UK calendar is quite well filled with the Money supply data (including credit statistics) and the manufacturing PMI. Credit data weren’t that bad of late. The manufacturing PMI showed a loss of momentum over the previous months, but there were signs of bottoming out last month (rebound from 51.4 to 51.9). For August a marginal increase to 52.00 is expected. We don’t have strong arguments to take a different view from the consensus.
The UK economic recovery is in the first place driven by domestic demand and by the activity in the services sector. So, the services PMI (published on Thursday) is probably more important for markets (and for the BOE). That said, we look out whether sterling can profit in case of decent/stronger than expected UK data. BoE’s Carney at Jackson Hole repeated that a rate hike might come on the table of the BoE around the turn of the year. In this context, there is room for sterling to regain some ground against the euro and the dollar in case the eco data surprise on the upside of expectations. Despite recent sterling weakness, we maintain the view that the topside in EUR/GBP is rather well protected, with important resistance in the 0.7483/0.75 area. Interest rate differentials between the euro and sterling are still substantially in favour of the UK currency. A cautious sell-on-upticks approach might be considered.