Core bonds limit losses in final session of April

Rates

On Friday, global core bonds initially lost more ground despite risk aversion, mixed eco data and the end-of-month conditions. However, losses were erased (US) or partially recouped (Germany) in later US trading. In a daily perspective, the US yield curve barely changed with yields flat (2-yr) to 0.9 bps (10-yr) higher. Changes on the German yield curve were slightly bigger and ranged from +0.4 bps (30-yr) to +2.2 bps (5-yr). The early US data, PCE, PI and Employment Cost Index were too close to expectations to affect markets, but equity futures started to head south allowing core bonds first to stabilize then to recoup losses. The mid-morning US (Chicago PMI & Michigan consumer sentiment) were weaker than expected, but once more weren’t decisive market-wise. ECB chief economist Praet said that negative rates cannot be reduced to indefinitely lower levels, but didn’t exclude deploying negative interest rates again in the future in case of a distinct worsening of the inflation outlook. Dallas Fed Kaplan, who doesn’t vote on policy this year, said that he will advocate Fed action if Q2 data rebound. In line with other governors, he added that markets may be underestimating how soon the Fed will raise rates. Their remarks had little impact though.

US ISM and central bank talk main ingredients session

According to the preliminary estimate, the euro zone manufacturing PMI dropped marginally from 51.6 to 51.5 while a limited increase was expected. The final reading is expected to confirm this outcome, but we see risks for an upward surprise following an improvement in the EC’s confidence indicators and the IFO’s forward looking indicator. In the US, the manufacturing ISM is expected to have weakened from 51.8 to 51.5 in April following a sharp uptick in the month before. We believe that a weaker outcome is not excluded as regional confidence indicators reversed some of their March improvement.

Central bankers are active too with ECB’s Draghi, Weidmann, Lautenschlaeger and Fed’s Lockhart and Williams scheduled to speak. We don’t expect the ECB governors to break new ground on policy. The ECB is for some time out of the picture, as it wants to give previous measures the time to have their impact However, the rise of EUR/USD to near key resistance makes them nervous and could seduce them to some verbal intervention. The speeches of Fed Lockhart and Williams (both moderate centrists) are unlikely to affect markets as their subjects (welcome remarks/Systemic risk) suggest they may stay silent on policy.

Low EMU bond supply this week

This week’s EMU bond supply is limited to France, Germany and Spain tapping the market. On Wednesday, the French debt agency taps the off the run 30-yr OAT (6% Oct2025), the on the run 10-yr OAT (0.5% May2026) and the on the run 15-yr OAT (1.5% May2031) for a combined €7-8B. The German Finanzagentur auctions the on the run Bobl on the same day (€4B 0% Apr2021). This week’s auctions will be supported by €28B redemptions and coupon payments. The DBRS rating agency confirmed Portugal’s BBB rating (stable outlook). So, Portuguese bonds remains eligible for ECB purposes as the other Agencies rate Portugal as junk

Important test of core bonds’ health

This weekend, Chinese PMI manufacturing confidence (PMI) was reported at just 50.1 for April, slightly below the March reading (50.2) and the consensus (50.3). The Caixin manufacturing PMI was little changed at 49.8. The non-manufacturing PMI fell slightly to 53.5 from 53.8 previous. Japanese PMI was marginally higher at 48.2, but still below 50 boom/bust.
Glass is still half empty in China, or optimists will say half full. Asian markets are in risk-off mode, as Japanese equities drop more than 3% on stronger yen (106.60), but also other Asian bourses trade in the red (Chinese bourses are closed). Commodities are lower too and EUR/USD sticks near 1.1465.

Today’s eco calendar is light with only the EMU final PMI’s and the US ISM. We see some upside risks for the former, but as it as a final figure, market shouldn’t react too much. There are some downside risks for the US ISM which might be core bond positive. A new quarter starts and so we are on the lookout for maybe some new directions in markets, more in particular whether the risk-on has further to go. Our basic view is no and today’s early indications support our view. Riskier assets are richly priced and oil/commodities should be toppish. Central banks are side-lined and so are no support for riskier assets. Markets have priced in only one Fed rate hike by April 2017. Unless recession risks would rise, there is little scope for a still more gradual rate path. If it’s because of higher recession risk, that shouldn’t help the risk-on rally either. Of course, in recent weeks, especially the Bund traded weak, also in circumstances that would have justified a more bullish run. Also overnight, the risk-off was of little help for the US Treasuries that trade little changed from Friday. For the Bond we think that 160.81 is strong support (0.33% in 10-year German yield). So the downward correction of the Bund may have nearly run its course, unless these levels are broken which isn’t our favourite scenario. So we change our view on the core bonds from bearish to neutral.

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