Treasuries under pressure as bets on Summer hike rises

Rates

Global core bonds parted ways today. German Bunds traded sideways while US Treasuries lost some modest ground, especially at the 2-to-5-yr sector. Implied probabilities of a Summer rate hike by the Fed increased further after comments of Fed Harker, who confirmed earlier comments that the Fed could go as early as in Summer. A strong 2-yr US Note auction pushed 2-yr yields somewhat lower, but not enough to erase the earlier increase. Very strong New Home sales nurtured the idea the Fed could hike rates soon. German Bunds actually held up quite well against the background of surging European equity markets and a recovering oil price. In a daily perspective, German yields were virtually unchanged across the curve, while the US yield curve shifted 1.3 bps (2-yr) to 3.6 bps (5-yr) higher, the shorter end underperforming the longer end. On intra-EMU bond markets, peripheral 10-yr yield spread changes versus Germany narrowed up to 4 bps in the risk-on context. Greek bonds didn’t specifically outperform ahead of the Euro group meeting.

 

German IFO and central bankers in focus today

After a marginal drop in April, the German IFO business climate indicator is expected to have picked up slightly in May from 106.6 to 106.8. We believe however that the risks for the IFO are on the upside of expectations following remarkably strong German PMI’s earlier this week. US house prices and Markit services PMI are usually no market movers. ECB governors Linde, Villeroy, Knot, Constancio and Praet speak throughout the day. We will listen careful, but don’t expect new info with market implications. Fed Kashkari, Harker and Kaplan speak too, but have already spoken recently.

 

Greece reaches breakthrough deal with creditors

Greece, the EU and the IMF reached a quite complicated deal. First and foremost, Greece will get €10.3B in fresh loans starting with a €7.5B instalment in the second half of June. It will allow Greece to satisfy its ST debt service obligations (to IMF and ECB) and start the clearance of part of the arrears as support for the real economy.
A complicated compromise had been reached with the IMF (and especially Germany) on some debt relief. It consist of ST, MT and LT measures that however all still need to be negotiated and agreed in due time. Germany accepted the principle of debt relief while the IMF accepted that the most important debt-relief measures wouldn’t be enacted until at least 2018, when the Greek bailout ends. So, it’s a compromise. The debt relief package should keep Greek debt financing costs below 15% of GDP until 2030 and 20% after that. Before 2018, the ESM will rearrange its loan book with the aim of smoothing its payment profile and reducing interest risk.

 

Very strong US 2-yr Note auction

The German Finanzagentur taps the off the run 30-yr Bund (€1B 2.5% Jul2044). Tapping off the run Bunds (only 30-yr) is a new feature in this year’s German funding strategy. The Bund on offer didn’t cheapen in ASW-spread terms in the run-up to the auction, but trades normal at the very long end of the German yield curve. Total bids at the previous 6 30-yr Bund auctions averaged €1.27B and we don’t expect much improvement today. The US treasury started its end-of-month refinancing operation with a very strong $26B 2-yr Note auction. The auction stopped more than 2 bps below the 1:00 PM bid side and the bid cover was high (3.00). The backup in yields appeared to outweigh short-term Fed rate hike concerns. Bidding details showed an especially large and aggressive dealer bid. Today, the Treasury holds a $34B 5yr Note auction and a $13B 2-yr FRN auction. Currently, the WI of the former trades around 1.41%.

 

Trading driven by risk sentiment

Overnight, Asian stock markets build on strong risk sentiment in Europe and the US yesterday. Main indices gain more than 1% with China underperforming and recording smaller advances. Brent crude holds on to yesterday’s gains and hovers above $49/barrel. The US Note future trades more or less stable, suggesting a neutral opening for the Bund.

Today’s eco calendar contains German Ifo. Risks are on the upside of expectations, but European eco data can’t leave a trace on markets at this stage. Several ECB members speak, but their message is well-known. Fed Harker, Kashkari and Kaplan already shed their views. Overall, we have no strong view for today’s trading. If yesterday’s rally on equity/commodity markets persists, it could further weigh on core bonds. On peripheral markets, Greek bonds should continue to outperform following the Eurogroup’s approval to disburse the next aid tranche.

Longer term, the Bund remains in the sideways channel between 160.81 and 164.60. We would sell on upticks near the resistance for a move back deeper in the range. In yield terms, 0.07% is key support for the German 10-yr yield. The US Note future trades in the middle of the 128-01+ to 131-14 sideways range. A June rate hike is a plausible scenario, which is far from completely discounted by markets. Therefore, we expect more price action towards the downside of the range. Short-term (2y/5y) spread differentials between the US and Europe could widen further on the hawkish repositions of US bond markets. The front-end of European yield curve is locked by the ECB’s easy monetary policy.

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