Rates

Core bond rally extended

Weakness in equity markets and declining oil prices took over command in bond markets yesterday. Monday’s profit taking move proved to be a one-off. US Treasuries outperformed German Bunds. At the end of the day, the German yield curve shifted 0.9 bps (2-yr) to 4.4 bps (10-yr) lower. The US yield curve bull flattened with yields 7.9 bps (2-yr) to 10.5 bps (30-yr) lower. The US 10-yr yield fell below the 1.9% support and tested a final (minor) hurdle (1.82%) before last year’s low at 1.64% comes on the radar. Hawkish comments by Fed George (voter) didn’t weigh on US Treasuries. She said that “the recent bout of volatility is not all that unexpected, nor necessarily worrisome, given that the Fed’s low interest rate and bond-buying policies focused on boosting asset prices as a means of stimulating the real economy.” Therefore, it’s no reason to further delay more rate hikes. “If we wait for the data to provide complete confirmation before making a policy decision, we may well have waited too long.”

On intra-EMU bond markets, 10-yr yield spread changes versus Germany widened up to 2 bps with the periphery underperforming. The Spanish/Italian spread added 6 bps, the Portuguese one 10 bps and the Greek one 19 bps. In Spain, Socialist leader Pedro Sanchez was given a mandate to try to form a government. He will try to negotiate a potential government coalition in order to avoid new elections. The current political deadlock suggests that his chances are rather slim.


Modest profit taking on overbought conditions

The eco calendar is interesting today with the final reading of the EMU services PMI, the EMU retail sales, US ADP employment report and US non-manufacturing ISM. According to the 1st estimate, the EMU services PMI dropped from 54.2 to 53.6 in January, while a stabilization was expected. Data from Germany and France were mixed with the German services PMI weakening significantly, while the French one rebounded. The final reading is expected to confirm the first outcome. Although revisions will probably be limited, we see risks for an upward surprise. EMU retail sales are expected to have rebounded slightly in December, rising by 0.3% M/M following three consecutive monthly declines. We continue to see downside risks following poor data from Germany, Portugal and Spain. Only French consumer spending picked up in December, following the Paris attacks in November.

In the US, the non-manufacturing ISM is expected to have declined slightly further in January, from 55.8 to 55.1. In December, the details were quite strong and the initial figure was also slightly upwardly revised. We believe therefore that the consensus might be too pessimistic. Finally, ADP employment will be interesting too ahead of Friday’s payrolls. The consensus is looking for an increase in private sector employment by 193 000 from 257 000 in December. After strong hiring in the fourth quarter of last year, we believe it might slow somewhat early 2016. We see downside risks. Finally, the EC’s Winter Economic Forecasts will be interesting too. We don’t expect major changes in the GDP forecasts (respectively at 1.8% for 2016 and 1.9% for 2017), but inflation forecasts (currently at 1.0% for this year and 1.6% next) will probably be revised lower, especially for this year.


Ohn de German Bobl auction

Today, the German Finanzagentur launches a new 5-yr Bobl (€5B 0% Apr2021). On the grey market, the new Bobl trades with a 0.4 bps pick-up in ASW spread terms compared with the previous benchmark (0.25% Oct2020). That corresponds with a 5 bps pick-up in yield terms. Overall, we expect more weakness at this German auction given record low negative yields (even below ECB deposit rate!).


Bund remains in overbought conditions

Overnight, Asian equity indices lose ground like Europe and the US yesterday. Japanese stocks underperform on the back of a stronger yen. A strong Chinese services PMI couldn’t turn the tide. The oil price trades stable around yesterday’s low. The US Note future reached a minor new contract high.

Today’s eco calendar heats up with final EMU services PMI, EMU retail sales, US ADP employment and US non-manufacturing ISM. Especially the US eco data could be relevant for markets. The outcome might be mixed, but in current sentiment especially negative surprises could leave traces on markets. While short-term profit taking moves in overbought markets (both Bund and US Note future) are not excluded, sentiment remains positive for core bonds. Weakness in equity market/oil prices and the dovish turn of global central banks (ECB, BoE, BoJ and Fed) pulled yields lower. Technically, the German 10-yr yield fell below final support (0.42%). That opens the way for a complete retracement towards the all-time low at 0.05%. The US 10-yr yield dropped fell below 1.9%. From a technical point of view, this also suggests more downside towards 1.64%.

This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.

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