Spain and France tap the market

Rates

Yesterday morning, global core bond trading continued in a narrow range, though still with a small downward bias. There was some ongoing repositioning in the Bund market, but still within the established trading range. Selling intensified during the US session following a strong ADP report with the 5‐to‐7‐yr sector taking the brunt. First key support in the T‐Note future was finally broken, while the 2.80% area resistance for the 10‐yr yield is under test. Markets are clearly positioning for a stronger US payrolls report. German Bunds followed US Treasuries lower, but the decline wasn’t technically relevant. It was the fourth consecutive session core bonds lost ground. In a daily perspective, US yields were up to 6.1 bps higher, the 5‐7‐yr underperforming. German yields rose by 1.5 to 4.3 bps, the 10‐yr underperforming.

According to the first estimate, the euro zone services PMI weakened slightly in March (from 52.6 to 52.4). The final reading is expected to confirm this outcome. More interesting might be the retail sales. Euro zone retail sales started the year on a positive note. In January, retail sales picked up by 1.6% M/M, following a poor December reading. For February, the consensus is looking for a limited payback, by 0.5% M/M. German retail sales came out remarkably strong and therefore we believe that the risks for the euro area are on the upside too. In the US, the March non‐manufacturing ISM is forecast to reverse most of its previous month’s drop, as the consensus is looking for a rebound from 51.6 to 53.5. We believe that the non‐manufacturing ISM might be supported by more favourable weather conditions and therefore see risks for an even stronger outcome. US initial jobless claims are expected to have edged up from 311 000 to 319 000 in the week ending the 29th of March. In the previous week, claims dropped to their lowest levels since the end of November and therefore a pick up is likely.

The ECB meeting will get all attention (see our flash report for full coverage). The ECB statements earlier this month, combined with the low March inflation readings at first suggested that the ECB may ease its policy at the April meeting. We think though that the chances of such an outcome are small. It would hit the credibility of the ECB, one month after they suggested that they may have finished their easing cycle and amid signs the economic recovery is ongoing.
Reacting on one monthly set of inflation data would convey the message the ECB is putting too much emphasis on the monthly news flow of economic information. The ECB will want a few more months of information to come to an eventual different reasoning that points to more easing. However, Mr Draghi is likely to strike a dovish tone that will encourage markets to debate exactly what circumstances might be needed to cause the ECB to ease again.

Spain and France tap the market. The Spanish treasury taps the on the run 5‐yr Bono (2.75% Apr2019) & 10‐yr Obligacion (3.8% Apr2024) and the off the run 15‐yr Obligacion (5.9% Jul2026) for a combined amount of €4.5‐5.5B. The bonds didn’t cheapen in ASW spread terms going into the auction. Over the past month, the 5‐yr sector of the Spanish yield curve outperformed. This 5yr‐10yr steepening could be supportive for demand at the longer‐dated bonds tough the Apr2024 trades rich in that specific sector. Compared to Italy, Spanish bonds don’t give additional spread pick‐up. Overall, we think the auctions will continue to go well, driven by ongoing positive sentiment towards peripheral bonds. The French debt agency auctions the off the run 15‐yr OAT (3.75% Apr2021) and the on the run 10‐yr OAT (2.25% May2024) & 30‐yr OAT (3.25% May2045) for a total amount of €6.5‐7.5B. All in all, French bonds trade relatively stable in ASW‐spread terms, though there was some widening following this weekend’s local elections. This could prove supportive for the auctions.

Overnight, most Asian equities trade positive. The Chinese government announced new infrastructure spending to boost growth and Chinese services PMI’s were mixed. The US Note future trades flat amid hawkish comments by St.‐Louis Fed Bullard. He thinks the Fed should start hiking rates in Q1 2015 and eyes a 4.25% policy rate by the end of 2016

Today, the ECB holds its monthly policy meeting. We don’t expect a policy change, which should add to the downward momentum on bond markets. If the ECB surprises, with eg a small refi rate cut, the Bund could go for a test of the high. Nevertheless, unless the nuclear option is used (QE) we don’t think there is much lasting upward potential for the Bund. Later in the US session, we get the non‐manufacturing ISM. We see risks for a stronger outcome in which case the US 10‐yr yield could break above 2.8% resistance and pave the way for return action towards 3%, especially if we also get a strong payrolls number as well tomorrow.

Technically, the US Note future fell below 123‐02+ support yesterday following the strong ADP report. It’s a first sign that the picture is deteriorating. Once the US 10‐yr yield trades north of 2.8%, the path towards the 121‐08+ contract low is completely open. For the Bund and the German 10‐yr yield, important support (141.20) and resistance (1.70/75%) levels are still further away, but could rapidly come within reach if US yields start a new upleg.