The Bund traded sideways in the morning

Rates

Yesterday, in thin trading, core bonds ceded some additional ground and closed with modest losses. German bond yields were up 2-3 bps, the US marginally more. The Bund traded sideways in the morning. Some losses in sympathy with gilts following the publication of the UK inflation report were recouped when ECB Coeure said the ECB is seriously considering negative deposit rate. In the US session, core bonds gradually slid lower, likely partly due to the upcoming 10-yearT-Note auction. The latter went okay, but caused little reaction anymore.

Today, the eco calendar heats up, especially in the US with the retail sales and jobless claims data. Following a 0.2% M/M increase in December, US retail sales are expected to come out flat in January. Gasoline station sales are forecast to have dropped at the start of the year due to lower gasoline prices, while vehicle sales were probably close to flat. As a result, retail sales excluding autos and gas are forecast to show a limited 0.1% M/M increase in January, while expectations for the control group are at 0.2% M/M. We believe that the risks are for a downward surprise partly due to poor weather conditions. Nevertheless, weakness will be partly offset by a substantial increase in food store sales. Also in the US, weekly jobless claims are forecast to have stayed broadly unchanged in the week ending the 8th of February. The consensus is looking for a marginal drop from 331 000 to 330 000. Seasonal adjustment factors are however favourable, which might push the reported claims somewhat lower.

The policy debate inside the ECB council is very alive since Mr. Draghi suggested that the ECB needed more information before taking a decision (in March?) whether further easing was needed to fight the very low inflation. ECB Coene said yesterday that the drop in inflation to 0.7% in January ”isn’t a sufficient element to decide we absolutely have to do something.” The ECB must look closely at developments in peripheral countries to assess whether the drop represents a temporary adjustment or a sign of deflationary tendencies. “It depends on what you expect inflation will be thereafter”. Is the low inflation a one-time adjustment that’s the result of what’s happening in peripheral countries, where you have negative price developments which are basically an adjustment of prices to a new equilibrium, or is it a real development of deflationary tendencies? ECB Coeure said that the ECB is considering a negative deposit rate “very seriously”, but you should not expect too much of it. ECB Noyer suggested that the euro was too strong, while ECB Hansson was quoted as reserved on the use of QE. In the run up to the March meeting, ECB speakers will get a lot of attention in the markets as their comments are market moving.

The Italian debt agency taps the on the run 3-yr BTP (€3-3.5B 1.5% Dec2016), 7-yr BTP (€2-2.5B 3.75% May2021) and 30-yr BTP (€1-1.5B 4.75% Mar2044). In the run-up to the auction. In the run-up to the auction, only the 3-yr BTP cheapened significantly in ASW spread terms (6 bps) whereas the 7-yr BTP trades around 4 bps cheaper than the surrounding 3.75% Mar2021 and 3.75% Aug2021 BTP’s. The Italian pick-up over Spain has been reduced or even vanished since the start of the year, offering little relative value. While sentiment towards periphery remains supportive, the recent Italian game of chess between Letta and Renzi could be a hampering factor for today’s auction. The Irish treasury (NTMA) released a funding statement for 2014. NTMA wants to raise €4B through a series of bond auctions this year with indicative sizes ranging between €0.5-1B. It is planned to hold one or two auctions per quarter with the first one taking place Mar13. Furthermore, NTMA explores the opportunity of a switch auction where investors could change their 4.6% Apr2016 IGB’s for longer dated bonds.

In the US, the Treasury continued its refinancing operation with a mixed $24B 10-yr Note auction. The bid cover was light (2.54 versus 2.71 average last year), but the auction still stopped through the 1:00 PM bid side. Bidding details were solid with again a strong indirect bid. Today, the US Treasury concludes its mid-month refinancing operation with a $16B 30-yr Bond auction.

Overnight, most Asian equity indices trade negative with Japan underperforming on the back of a stronger yen. Australian employment data disappointed and weigh on the Aussie. The US Note future is higher, suggesting some risk-off at the start of trading.

Today, the eye-catcher are the US retail sales. We expect a weaker outcome, which should be supportive for core bonds. Italian politics could be interesting as well for market sentiment, especially on peripheral bond markets. Renzi will give a press conference and might give more details on chances of a government reshuffle and change of PM. So far, there were no signs of a negative impact, but after hitting fresh multiyear lows in Spain/Italy, a correction could be on its way.

Last week several bond positive factors ebbed away. First, tensions on EM eased. Second, the ECB refrained from easing monetary policy. Third, US eco data were not as bad as feared and multiple Fed governors indicated that it takes a lot more to derail the FOMC from its QE tapering path ($10B each meeting = default mode). If we see our view confirmed this week and the recent highs (144.57 Bund; 126-16 US Note future) manage to hold as resistance levels, we consider installing new short positions.