Temporary profit taking after US payrolls

Rates

Dovish positioned global core bonds initially fell prey to profit taking on the back of mixed payrolls. Headline payrolls disappointed, but the unemployment dropped to a cycle low of 4.9% (Fed’s target), participation rate and workweek rose and average hourly earnings strongly exceeded expectations. However, as equities sold off too, US Treasuries were able to turn the tide on a safety bid, recouped losses and ended mixed. The front end of the curve underperformed, maybe as the details kept the idea of Fed tightening at some point in the future alive. In a daily perspective, the US yield changes ranged between + 2.4 bps (2‐yr) and ‐0.7 bps (30‐yr). The German yield curve dropped 0.6 bps (2‐yr) to 2.1 bps (30‐yr) lower. However, the US bond rally wasn’t finished when EMU cash markets closed. On intra‐EMU bond markets, 10‐yr yield spread changes versus Germany showed a lot of dispersion with Spain flat, Italy +3 bps, while Greece and Portugal traded 10/11 bps wider. The Portuguese government awaited the Commission’s decision on its budget proposal.

Fitch upgraded the Irish A‐ rating (positive outlook) to A (stable outlook). Fitch justifies the upgrade by an improvement in debt dynamics, reflecting the combination of strong growth and a return to a primary budget surplus. It forecasts debt/GDP at 96.6% from an earlier estimated 105% and a 120% high in 2012. Fitch expects the ratio to drop to 70% by 2024. The rating agency also confirmed the Austrian AA+ rating (stable outlook).

The eco calendar is nearly empty today, both in the US and euro zone. Eco data remain few throughout the week with German production on Tuesday and US retail sales, EMU production and US Michigan sentiment (all Friday) the only potential market movers. Chinese markets are closed in observance of the Lunar New Year holidays. Chinese FX reserves fell $99.5B to $3.23T in January according to the PBoC. That’s less than the $108B in December and below the $120B consensus estimate. The PBoC has recently stabilized the yuan, but at the expense of FX interventions. The decline is likely due to the repayment of dollar debt by Chinese firms, but also to capital flight by firms, households and speculators. The Chinese authorities took measures to stem the capital outflow, but it is unclear how much successful they are. In the next months it should be become clear whether the haemorrhage of reserves stops or whether China should stop intervening, defend FX reserves and let the yuan depreciate, which would stoke more global markets unrest. The January decline in reserves is as such no reason to panic and doesn’t weigh on Asian equities overnight.

Looking further ahead, Fed vice chairwoman Yellen gives her semi‐annual Congressional testimony on Wednesday. We expect her to comment on January turmoil in riskier markets and what it means for Fed policy. Her response is complicated by last Friday’s payrolls. On the one hand, slower job growth (and slower eco growth) is a reason to preach cautiousness on rates. On the other hand, the lower unemployment rate (full employment), higher participation rate, at last signs of stronger wage growth and the very dovish market positioning, point to keeping her message of gradual tightening in place. It would be odd to start the tightening cycle in December and call its “end” by February. It would lead to a loss of confidence in the Fed and create an image that the Fed has no good view on what’s happening. This could be dangerous for riskier markets. So, she will have to give a finely balanced speech to avoid more turmoil.

Today: Technically-inspired trading

Overnight, Asian equities trade slightly higher, but several markets are closed (China, Hongkong, Indonesia, Malaysia, South Korea, Taiwan, Singapore). Chinese FX reserves dropped to the lowest level since 2012, but the decline was somewhat less than expected. The US Note future trades marginally lower suggesting a neutral to slightly weaker opening for the Bund.

Today’s eco calendar is empty. Apart from Wednesday’s Yellen testimony and Friday’s retail sales, the calendar isn’t that enticing later this week either. This means that technical factors and risk sentiment will drive trading. Both the Bund and the US Note future are still overbought, which make them vulnerable for bouts of profit taking. Equity markets remain at key support levels (eg Dax and S&P 500) while the recovery of oil prices is still tough going. It’s hard to say which factor will take the upper hand today, so we have a neutral view at the start of this week.

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 theoretically 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%. Longer term sentiment remains positive for core bonds, but any lasting improvement in riskier markets may trigger profit taking.

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