Renewed equity weakness prevent bond correction

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Renewed equity weakness prevent bond correction Yesterday, global core initially fell prey to modest profit taking as risk sentiment on European stock markets improved, just like the day before. Yellen’s comments for Congress were balanced, but the Fed chairwoman was slightly more dovish on the outlook. Maybe to the surprise of markets, she didn’t explicitly exclude a March tightening. Therefore, the yield curve bear flattened slightly. However, US equities couldn’t hold on to an early bid and slid again lower, erasing early gains. US Treasuries turned north and rallied to nice daily gains. The initial bear flattening turned to a robust bull flattening with yields 0.4 bps (2-yr) to 6.2 bps (30-yr) lower. The German yield curve ended nearly unchanged for tenors up to 10-yr with yields less than 1 bp higher. The 30-year yield added 2.6 bps. On intra-EMU bond markets, 10-yr yield spreads versus Germany narrowed 4 to 7 bps with Ireland outperforming. Greece and Portugal lagged with spread widening of 13 bps and 3 bps.

During US dealings, Fed chairwoman Yellen’s testimony before Congress took centre stage. In her written statement, she sounded cautious on the US’ economic outlook. Risks stem from China while financial conditions became less supportive (sliding equity prices, higher credit spreads, stronger dollar): “These developments, if they prove persistent, could weigh on the outlook for economic activity and the labour market”. She added that the Fed still expects to raise interest rates gradually, but the Fed would likely move slower “if the economy were to disappoint or faster if economy would strengthen more than anticipated”. Overall, her tone was slightly more dovish (on the outlook) compared with the January policy statement, but markets were maybe disappointed that she kept the door open for near term tightening (without any hint to the timing). The Q&A didn’t bring market relevant information.

In the week ending the 6th of February, US initial jobless claims are forecast to have edged slightly lower following an uptick in the week before. Initial claims are forecast to have dropped by 5 000, from 285 000 to 280 000. We have no reasons to distance ourselves from the consensus. Claims might remain somewhat higher than in the fourth quarter, when they were probably depressed by favourable weather conditions.

Italy, Ireland and US tap the market

The Italian debt agency taps the on the run 3-yr BTP (€1.5-2B 0.3% Oct2018), the on the run 7-yr BTP (€2-2.5B 1.45% Sep2022) and the off the run 15-yr BTP (€0.5-1B 3.5% Mar2030). In the run-up to the auction, the bonds cheapened slightly in ASW spread terms. On the Italian curve, the Mar2030 BTP is rich, while the Sep2022 BTP trades slightly cheap. Given current market sentiment, it could prove to be a tough auction, but investors should eventually manage to digest the relatively low amount on offer. The Irish treasury auctions the on the run 10-yr IGB (€1B 1% May2026). The bond cheapened in ASW spread terms since the successful launch in January and also trades rich on the Irish curve. Nevertheless, sentiment towards Ireland remains strong and we expect no difficulties. The US Treasury continued its mid-month refinancing operation with a mixed $23B 10-yr Note auction. The bid cover was the smallest since last August, but the auction stopped well below the 1:00PM bid side. Bidding details showed solid buy-side demand (both direct and indirect bids), but a disappointing dealer bid. Today, the Treasury ends its refinancing operation with a $15B 30-yr Bond auction. Currently, the WI trades around 2.5%.

Today: Risk aversion still at play

Overnight, risk aversion is again name of the game with Asian stock markets lower (China and Japan are closed), a stronger yen and upwardly biased US Note future. This suggests a stronger opening for the Bund as well.

Today’s eco calendar is empty apart from US weekly claims (irrelevant for trading) and Yellen’s testimony (repeat of yesterday). Risk sentiment and technical factors will continue to drive trading. European equity markets lost another important support level, suggesting more downside (risk off, positive core bonds). The S&P 500 is still testing crucial support (see graph above). Oil prices are back in tail spin and support the Bund. So longer term sentiment remains positive for core bonds (also taking into account the technical picture), but both the Bund and the US Note future are heavily overbought, which make them vulnerable for bouts of short term profit taking if risk sentiment improves. This week, the latter was often the case during European dealings, while sentiment soured again in the US and Asia.

Technically, the German 10-yr yield fell below final support (0.42%).
Weakness in equity market/oil prices and the dovish turn of global central banks (ECB, BoE, BoJ and Fed) pulled yields lower since the start of the year. The break lower opens the way for a complete retracement towards the all-time low at 0.05%. The US 10-yr yield dropped below 1.9%. From a technical point of view, this also suggests more downside towards 1.64%.

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