Disappointing bond performance amid risk off sentiment

Yesterday, global core bonds had a disappointing trading session. They failed to (fully) profit from huge risk off sentiment with European and US equity indices almost 3% lower and despite big bond losses on Monday. The asymmetrical behaviour of core bonds (significant losses when risk on; marginal gains for risk off), which started around mid-August, thus remains in place and confirms our hypothesis that the topside for the US Note future and the German Bund remains well protected. Weak Chinese, EMU, UK and US manufacturing business sentiment couldn’t help the core bonds much either. In a daily perspective, US yields shift 3.3 bps (2-yr) to 6.6 bps (10-yr) lower, the belly outperforming the wings. Changes on the German yield curve are limited between -0.9 bps (30-yr) and +0.7 bps (5-yr). The changes on the intra-EMU bond markets are again rather small with 10-yr yield spreads versus Germany up 2.8 bps for Greece, 4 bps for Italy/Spain and 8.5 bps for Portugal.

Boston Fed Rosengren, a non-FOMC voter with a dovish bias, said uncertainty over inflation and global growth justify a modest pace of interest-rate increases, regardless of when the Fed starts tightening. The Fed funds rate in the longer run may be lower than in previous cycles. He acknowledged that employment conditions had been largely met by strong job growth, but the data on inflation were not as clear-cut. Rosengren was cautious about the timing of the lift-off, which suggests it is a close call, but stressed the gradual nature of the tightening cycle and the lower long-run FF rate. Given his dovish orientation, he is not a key/crucial member of the FOMC and thus less influential on markets.

Attention for US ADP employment, orders and Beige Book

In August, the US ADP employment report is forecast to show an increase in private sector hiring by 200 000, slightly up from 185 000 in July. Incoming data for August have been quite strong with jobless claims remaining close to their lows, while business confidence indicators showed a more mixed picture. Nevertheless, we believe that hiring probably remained on track, in line with recent month’s data. Over the previous months, the ADP report tended to slightly underestimate the actual BLS reading, which might remain the case in August. We believe therefore that the risks for the ADP report remain for a slightly weaker outcome, although we don’t expect a material change from the consensus. Following strong durable goods orders, also factory orders are forecast to have increased further in July. The consensus is looking for a rise by 0.9% M/M following a 1.8% M/M increase in June. We see upside risks for the factory orders too, although non-durables might have dropped slightly.

Another difficult Bobl auction

The German Finanzagentur taps the on the run 5-yr Bobl (€4B 0.25% Oct2020). In the run-up to the auction, the bond on offer cheapened a few bps and the bond trades also slightly cheaper on the German curve. Total bids averaged €4.03B at the previous 4 Bobl auctions and we fear weak demand today as well. The Portuguese debt agency is expected to launch a new 7-yr deal via syndication in the near future, subject to market conditions.

Today: ADP

Overnight, Asian stock markets trade again very volatile. Most indices opened significantly lower (China up to 5%) but regained some ground going into European dealings. Chinese indices initially succeeded an impressive turnaround likely because of interventions ahead of a two day holiday in China (“Victory Day”). However, at the moment of writing, Chinese indices traded again in the red. Volatility remains the name of the game. The US Note future trades rather stable, suggesting a neutral opening for the Bund.

Today, the eco calendar contains the ADP employment report in the US. Risks, if any, are slightly on the downside of expectations. For markets, such outcome isn’t expected to trigger large moves. If equities recover from yesterday’s beating, we might be up for a calm trading session ahead of the ECB meeting and the payrolls. Yesterday, the US Treasury market couldn’t profit from a weaker manufacturing ISM even despite reigning risk aversion. This suggests that markets attach a decent probability to a September Fed hike and don’t want to be long ahead of the payrolls/FOMC. The past weeks, core bonds also reacted asymmetrically on risk sentiment. Losses in risk-on are larger than gains in risk-off. More prices swings in the oil price are a wildcard for trading.

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.