Core bonds profit from equity/oil weakness

Next Report will be published on Monday 9th of May 2016

Rates

Global core bonds had strong day, which wasn’t the case in the past sessions. They rallied higher, as equities and the oil price dropped, even as the intra-day correlation of the moves between markets wasn’t always perfect. The eco calendar was empty. However, the EU Commission Spring forecasts showed downward revisions of growth and inflation in the euro area, which was slightly supportive for core bonds, as were weak UK and Chinese manufacturing PMI’s. Volumes traded were well above average. US yields were 3.6 bps (2-yr) to 7.6 bps lower, the belly outperforming. The German yield curve bull flattened with yields down by 1.7 bp (2-yr) to 7.3 bps (30-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany were slightly higher with underperformance of Italy/Spain/Portugal (+5 bps) and Greece (+10 bps).
The spread widening occurred partly ahead of the publication of the EC Spring forecasts, which emphasized budgetary/debt problems for the periphery.

Eco calendar heats up

According to the flash estimate, the euro zone services PMI picked up marginally in April, rising from 53.1 to 53.2. The final reading is expected to confirm this outcome, but we believe that a slightly stronger outcome is possible following better than expected manufacturing PMI and EC confidence indicators. Retail sales are expected to have dropped slightly (0.1% M/M) in March, for the first time in five months. It suggests that the early timing of Easter failed to boost sales. We see risks for a downward surprise following strong data in the previous months. In the US, hiring is expected to remain on track with the ADP employment report expected to show a 195 000 increase in April, marginally down from the 200 000 in March. We believe that the risks are for an upward surprise following a month of very strong claims data. The US non-manufacturing ISM is expected to increase for a second straight month, rising from 54.5 to 54.8, following a 1-point increase in March. Improving weather conditions might support activity in several sectors and we believe therefore that the risks are for a more substantial increase. Finally, the trade balance is expected to show a significant narrowing in the deficit from $47.1 billion to $41.3 billion, mainly due to a sharp drop in imports.

France and Germany tap the market. 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. As usual, we don’t expect any problems. The German Finanzagentur auctions the on the run Bobl (€4B 0% Apr2021). German auctions often went more difficult recently, but without influencing the secondary market. Tomorrow, Spain will also tap the market. This week’s auctions will be supported by €28B redemptions and coupon payments, which is a positive.

Downward correction core bonds over?

Overnight, news was scarce and market moves don’t give clues for the European and US session. Asian equities are slightly to modestly weaker, but not weaker than the close of WS implies. The dollar is a bit stronger following the two day sell-off, while commodities are more or less stable. The T-Note future is marginally higher, but also here the closure of Japanese markets and some Asian follow through buying means we shouldn’t take it as a pointer for European trading. We expect the Bund to open unchanged to slightly higher.

Today’s eco calendar interesting, especially US-side. The EMU data might be mixed and thus neutral for the core bonds, but we see upside risks for the US ADP employment report and the non-manufacturing ISM, which is a bond negative. Investors though will start looking forward to Friday’s payrolls and stay sidelined. Following yesterday’s strong bond rally and equity weakness, there might be some profit taking in core bonds today if the US data come out strong. Markets may remember Fed’s Williams overnight comments that he would support a June hike if eco data and inflation would go the right side, but a lot can occur before June meeting he added. We doubt the risk-on has further to go. Riskier assets are richly priced and oil/commodities should be toppish. Major central banks are side-lined and so are no support for riskier assets. Markets have priced in only one Fed rate hike for March 2017. Unless recession risks would rise, there is little scope for a more gradual rate path. Of course, in recent weeks, especially the Bund traded weak, also in circumstances that would have justified a more bullish run, but that changed yesterday. For the Bund, we think that 160.81 is a strong support (0.33% in 10-year German yield). The downward correction of the Bund may have run its course. We changed our view on the core bonds from bearish to neutral (160.81 to 164.60).

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