The October German factory orders disappointed

Markets: Rates

On Friday, the sell-off on core bond markets stopped, despite a very solid US November payrolls report. On the release, the downside was tested, but rejected. In the rebound action, the curve flattened. In other markets there were similar knee-jerk reactions. Equities ended with good gains in the close. The dollar advanced against the yen, but interestingly lost ground versus the euro. German bonds mirrored the moves of US Treasuries, keeping the ‘Atlantic spread’ virtually unchanged.

Intraday, the Bund opened a bit lower but erased these losses in the first trading hour. Afterwards, prices slid in a very tight range awaiting the release of the US payrolls report. The October German factory orders disappointed, while banks continued to repay their LTRO loans at a fairly brisk pace of more than €7B/week. However, unsurprisingly, these reports were bluntly ignored. The US payrolls were solid. A nice headline job growth figure and a surprisingly steep drop of the unemployment rate to 7%, the level once put forward by Bernanke as the level unemployment would be when the tapering would FINISH!! It hasn’t even started!! Also the secondary details of the payrolls were solid (see news section). On the release, US Treasuries dipped, as did EUR/USD and even equity futures. The rationale being that this report raised chances on a December tapering decision. However, there was no follow through selling, suggesting that the prepositioning for a strong report had done its job, at least for US Treasuries and equities. So, US Treasuries rebounded, erased intraday losses and even tried to eke out gains. However, the rally fizzled out and US Treasuries slid a bit lower.
In the rebound, traders took profit on steepeners. In yield terms, 2-and 5-yr US yields were slightly higher (1.3 and 0.2 bps), while 10- and 30-yr yields dropped 1.6 and 2.5 bps. Moves in German yields were similar.

On intra-EMU bond markets, 10-yr yield spreads versus Germany narrowed for Italy (-3 bps) and Spain (-5 bps). (Semi-) core spreads widened up to 2 bps. Over the weekend, Matteo Renzi won the leadership of the biggest Italian political party (ruling center-left PD). The result was widely expected and should have no big influence on the BTP market. Renzi will meet with PM Letta and is expected to dictate conditions for continuing to support the government.

Next week, Letta will unveil a revamped reform platform, likely shaped to Renzi’s demands. In Greece, parliament approved the 2014 budget but the Troika postponed a planned mission to Athens as the stand-off over a fiscal gap and structural reforms continues. Greek lawmakers also approved next year’s budget in defiance of regulation that it should first be approved by the Troika.

Today, the eco calendar is thin with only German industrial production data and the final release of Greek Q3 GDP. Euro area Finance Ministers meet in Brussels and Fed Speakers are active (Lacker, Bullard & Fisher) ahead of the blackout period before the December FOMC meeting.

The Euro group meeting most likely won’t discuss and decide on important issues today. The extra financing for Greece is delayed to January and the banking union (resolution authority/ resolution back-up fund), is a subject for the Ecofin (Tuesday). On Friday, German FinMin Schaueble met with other key players to try to find an agreement on this important issue that should be formally agreed at the December 19-20 Head of State Summit, but still big divisions exist between Member States. Apparently, Mr. Dijsselbloem, head of Euro group, wants to split the issue and prepare now the ground for a decision on the Resolution authority and keep the more contentious issue of the back-up fund for later.

The speeches of Fed governors Lacker, Fisher (both hawks) and Bullard (more centrist) will be looked at from the angle of the timing of the start of the tapering of asset purchases. The former two are definitely in the camp of those who want to finish the programme as soon as possible. Bullard is still open-minded. He is concerned about too low inflation and possibly wants to buy more time for that reason. The key question, which is still unresolved, is how the decision will be communicated. Some governors say that a tapering decision should be accompanied by a limit on the size of the programme or a timetable for ending it. Another possibility mentioned is simultaneously cutting the interest paid on excess reserves to signal that the tapering doesn’t influence the timing of rate changes. Some want to lower the unemployment rate thresholds, while others advocate adding an inflation threshold. We don’t expect this discussion to be finished at the Dec 17-18 meeting and thus favour a tapering decision in the January or March meeting. Doing it in December when liquidity is thin is another disadvantage for deciding in December. However, it is not excluded that the FOMC is now convinced that a short pain is better and act next week.

In October, German industrial production is forecast to have picked up following a 0.9% M/M decline in September. The consensus is looking for an increase by 0.7% M/M. Recent business confidence indicators suggested that activity in Germany is picking up again in the fourth quarter, but order data remained quite volatile. We believe therefore that the consensus might be too optimistic. According to the first estimate, Greek GDP fell by 3.0% Y/Y in Q3. The data were however non-seasonally adjusted and no details were available so revisions are not excluded.

This week’s EMU bond supply is thin with only scheduled auctions in Austria (Tuesday) and Germany (Wednesday). The Austrian debt agency taps the off the run 10-yr RAGB (3.4% Nov2022) and the on the run 20-yr RAGB (2.4% May2034) for a combined €1.65B. The German Finanzagentur taps the on the run 2-yr Schatz (€5B 0% Dec2015). This week’s supply will be supported by a German Schatz redemption (€15B) and an Italian BTP redemption (€20B).

Overnight, Asian equities trade quite strong. The Japanese equities profit from a weaker yen, despite a downside revision of Q3 GDP. The Chinese trade surplus reached its highest level in years, allowing authorities to set the USD/CNY mid-rate at its lowest level ever. US Treasuries are a bit higher, while the Bund opened lower, but only in comparison with the official close.

The price action following the payrolls suggests that for now and ahead of next week’s FOMC meeting the downside for US Treasuries is limited. On the other hand, just because of the upcoming FOMC meeting and uncertainty about the outcome, the upside should also be limited. Supply is another factor. Therefore, we see the price action as mostly sideways oriented. In a longer term perspective, the technical picture of the US 10-yr yield still points to higher yields. Key support stands around 2.75% and key resistance at 3%. We expect this range to hold ahead of the FOMC meeting. Regarding the March Note future, a test of the downside was rejected Friday, which suggest that some corrective upside move is possible, albeit within the broader picture as painted for the 10-yr yield.

For the Bund, the technical picture turned bearish, after the Bund dropped below 140.56 sideways channel bottom with 139.46 the new correction low. The targets of the triple top constellation stand at 139.06/05 and 138.87. Also here some limited upside correction is possible, but as per US, it shouldn’t improve the technical picture in a sustained way.