The US Note future trades with a small upward bias

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Global core bonds traded range-bound, but with a negative bias yesterday. Europe waited on the ECB meeting (today) and the US waited on the official payrolls (tomorrow). The US eco data had some intraday effect. Weakness in the ADP report pushed core bonds higher, but the market was not ready to fully embrace the report, suggesting just like on Tuesday that the market is a bit too long bonds. So, bonds had already turned south again when a stronger a nonmanufacturing ISM was released, which added to the selling. However, also this move petered out and bonds stabilized. So all in all, yield changes were limited. In the US to less than 1 bp, while in Germany yields were up to 2.5 bps higher. Intra-EMU yield changes (10yr) were negligible.

Today, most attention will of course go to the ECB meeting and press conference. For a summary of our expectations see below and for a more thorough preview see our flash report . Other second tier EMU eco releases will stay in the shadow of the ECB and are unlikely to cause sharp reactions. The US eco calendar is thin too with only the initial claims as a possible market driver. Consensus expects a modest increase in initial claims to 310 000 from 300 000 previously. The previous reading highlighted a steep weekly fall which brought the claims back to the post crisis lows. In recent weeks, claims have been volatile. The week under review includes the Memorial Day holiday which may distort the outcome. Nevertheless, we put the risks to the downside of consensus. Ahead of the May payrolls (tomorrow) a sharp deviation from consensus may lead to some (late) repositioning in markets. Spain and France will hold bond auctions (see below) while Fed Kocherlakota will speak in Boston on “Low real interest rates”. He is one of the most dovish oriented governors. We don’t expect his speech to affect markets much on the eve of the payrolls release, but the speech might be interesting. He has an academic background and we expect him to argue why the equilibrium for real interest rates will be lower going forward than in past decades.

The Beige Book, a preparatory document for the next FOMC meeting (17-18 June), showed that the economy continues to recover from the winter soft patch. Indeed, 12 of the 12 Fed districts said growth was “modest” or “moderate”. Almost all districts described the outlook as improved or more positive, even if the tone remained a bit soft. We think the book will reassure the FOMC that it can safely decide a fifth $10B QE taper (to $35B/month), but also that it still has plenty of time to prepare for an exit out of the zero rate policy. So, this may clear (for the Fed) the horizon till after the summer.

The the Spanish treasury sells the on the run 3-yr Bono (2.1% Apr2017) and 5-yr Bono (2.75% Apr2019) for a combined €3.5-4.5B. The timing of the auction, hours before a pivotal ECB meeting, might hamper demand. However, sentiment on peripheral bond markets remains positive. In the run-up to the auction, both bonds cheapened 2-to-3 bps in ASW spread terms. Spain completed already 51% of this year’s total funding need. The French debt agency launches a new 10-yr OAT (1.75% Nov2024) and taps the off the run 10-yr OAT (3% Apr 2022) and on the run 15-yr OAT (2.5% May 2030) for a combined €7.5-8.5B. On the grey market, the new OAT trades with a 2.5 bps pick-up in ASW spread terms. This corresponds with a 11 bps pick-up in yields. The Apr2022 cheapened around 4 bps going into the auction and trades normal on the curve. The May2030 OAT is rather rich compared to the longer end of the French yield curve. Nevertheless, French auctions generally tend to go well and we don’t expect difficulties today neither. This week’s auctions won’t be supported by bond redemptions.

Overnight, Asian equity markets trade mixed and relative changes are small. The Chinese HSBC Services PMI for May fell from 51.4 to 50.7. The US Note future trades with a small upward bias.

Today, only one thing matters and that’s the ECB meeting. In the run-up to the press conference, trading will likely be subdued. The ECB announces interest rates ahead of the press conference but a refi- and deposit rate cut by 10 to 15 bps are discounted (see graph above). Second, Draghi is expected to announce measures to unblock the credit channel in the transmission mechanism. Measures can range from targeted LTRO’s ( directed to SME loans) to (the development of) and ABS purchase programme (SME ABS/covered bonds). An outright QE programme is unlikely at this stage, but Draghi will keep the door open, especially if the new inflation forecasts point to a more than cosmetic deterioration of the outlook. For markets, softness on prospect of QE/substantial downward revision of the inflation outlook might boost bonds somewhat further. All other measures are largely discounted by now, though markets might still be hesitant for instant profit taking (buy the rumour, sell the fact) with tomorrow’s US payrolls in mind.

Technically, the German 10-yr yield paints a double bottom on the charts. 1.44% is the neckline of this formation and 1st resistance (targets at 1.55% and 1.59%). The target of this double bottom corresponds with the 38% retracement of the Sep2013 to May2014 fall in yields and is key to change the technical picture to neutral. On the downside, the recent low of 1.30% is the only support that separates us from the all-time lows (1.12%.