US non-manufacturing ISM & ECB meeting in focus

Rates

Disappointing bond performance amid risk off sentiment

Yesterday, global core bonds traded sideways (US) to marginal upward (Germany) ahead of the US ADP employment report. Despite a slightly below consensus outcome (190K versus 200K), US Treasuries suffered a setback. After some volatility, they closed near the intraday lows as US stocks ended strong (+2%), while oil prices moved back above $50/barrel. All in all, bond moves didn’t go far in the absence of strong directional triggers and ahead of the ECB meeting (tomorrow) and the payrolls (Friday). In a daily perspective, the US yield curve bear steepened with yields 0.8 bps (2-yr) to 4.4 bps (30-yr) higher. Changes on the German yield curve ranged between + 0.5 bps (2-yr) and -3 bps (30-yr).

According to the Fed’s Beige Book, the US economy expanded across most regions and industries in July and August, in line with previous Beige Books. Six Fed districts qualified growth as moderate, while five said the growth was modest and one spoke about slight growth. No big surprises on activity, but interestingly most districts reported growth in manufacturing, a sector most hit by the global slowdown. Inflation remained benign, but several districts reported increasing wage pressures due to a tightening of the labour markets. All in all, the Beige Book doesn’t push the FOMC in one or another side regarding a potential lift-off at the September meeting. Incoming eco data and the state of markets might be decisive in the decision on interest rates.

US non-manufacturing ISM & ECB meeting in focus

The final reading of the EMU services PMI for August is forecast to confirm the 1st estimate, which showed a limited pick-up from 54.0 to 54.3. Earlier this week, the manufacturing PMI was revised slightly lower as strength in Germany was offset by a weakening in sentiment in most other countries. We believe that also the services PMI might come out somewhat weaker, although any revision will probably be limited. The EMU retail sales for July are the first hard data for the third quarter. After a drop by 0.6% M/M in June, the consensus is looking for a rebound in retail sales by 0.5% M/M in July. Earlier released national data (Germany, Spain, Portugal). We believe therefore that the risks are for a stronger outcome, boding well for growth in Q3. In the US, the non-manufacturing ISM is expected to reverse part of its strong July rebound, falling from 60.3 to 58.2 in August. We believe that some payback is likely following the exceptional uptick in July with even a bigger drop not excluded. Also regional business confidence surveys weakened somewhat, while global uncertainty and the prospect of higher interest rates might have weighed on sentiment too. Nevertheless, the index is expected to remain at lofty levels, pointing to healthy growth in the sector. The trade balance is expected to show a narrowing in the deficit from $43.8B to $42.2B, partly due to an oil-related decline in imports. Finally, US initial jobless claims are expected little changed compared with the previous week. The consensus is looking for an increase by 4 000 to 275 000, keeping claims in line with their recent trend.

Spain lowers net issuance second time

The French treasury taps two OAT’s (1.75% May2023 & 2.5% May2030) and launches a new 10-yr OAT (1% Nov2025) for a combined €7.5-8.5B. Grey market trading indicates that the new OAT will be priced to yield MS +7 bps, which is a 4 bps pick-up in ASW spread terms (9 bps in yield terms) vs the previous May2025 benchmark. Overall, French auctions tend to go well and we expect no difficulties today. The Spanish debt agency auctions the on the run 5-yr (1.15% Jul2020), 10-yr (2.15% Oct2025) and 30-yr Obligacion (5.15% Oct2044) for a combined €4-5B. The bonds cheapened a couple of bps going into the auction but the Oct2025 is rich on the Spanish curve. Yesterday, the Spanish government reduced its net issuance target for 2015 for a second time in less than two months. The target has been reduced from €55B to €51B in line with the evolution of the fiscal deficit. That could be supportive for demand.

Today: Dovish ECB and weaker non-manufacturing ISM?

Overnight, most Asian stock markets trade positive with Japan outperforming. Chinese markets are closed for V-J day. The US Note future trades marginally higher, but overall the Bund opening should be neutral.

Today, trading will likely be calm ahead of the ECB meeting. We expect no policy changes but a downward revision to inflation and growth forecasts. ECB’s Draghi will keep the door for more easing open without being as explicit as ECB Praet at the end of last week (increase scope, amount, length QE-programme because it will take longer to reach inflation target). Such a dovish message is a short term positive the Bund, but with payrolls/Fed in mind we think the upside potential is limited. The US eco calendar contains US non-manufacturing ISM. Risks, if any, are slightly on the downside of expectations. For markets, such outcome isn’t expected to trigger large moves. Earlier this week, the US Treasury market couldn’t profit (and even lost ground) from a (slightly) weaker manufacturing ISM & ADP report, suggesting 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.