Bonds sold off on strong ADP report

Rates

Yesterday, core bonds erased initial gains and closed moderately (Germany) to substantially (US) lower. The inability to follow through after setting new highs during the European morning session (Bund) and positioning ahead of the payrolls (and after strong ADP employment report) were the main drivers. The sell‐off continued until the US close. It left US yields up to 6.3 basis points higher on the day, steepening the curve. German yields rose by up to 3.8 basis points, also here steepening the curve. The US‐German 10‐year spread widened further, setting yet another cycle high (134 bps). The German OBL auction went well. Peripheral markets showed a mixed picture. Portuguese and Greek 10‐ year yield spreads were marginally lower, maybe due to the successful launch of a Portuguese new dollar 10‐year bond. The spreads of Italy and Spain widened 4‐5 basis points, ahead of today’s Spanish bond auction.

With US markets closed on Friday, the eco calendar is well‐filled today. US Nonfarm payrolls are the eye‐catcher, but also the US non‐manufacturing ISM, trade balance and jobless claims will be released. In the euro zone, the focus will be on the ECB meeting, while also the retail sales and services PMI are on the agenda. Spain (Bono/Obligacion) and France (OAT) will tap the market and Draghi and Germany’s Merkel, Schaeuble and Weidmann will speak at a CDU event.

In June, US non‐farm payrolls are forecast to have increased by 215 000, broadly the same pace as in the previous months. June payrolls are often subject to higher volatility related to the end of the school year, which creates volatility in educational workers. Besides government payrolls, also the leisure and entertainment sector is subject to increased volatility at the start of the holidays, as well as retail payrolls at the start of the sales period. To conclude, increased volatility makes it difficult to forecast June payrolls. Overall however, we believe that the risks are for a slightly stronger report as labour market conditions seem to have strengthened further during the month, reflected in lower claims and a string ADP report yesterday. The unemployment rate, on the contrary, is forecast to have stabilized at 6.3%. We believe that the risks, if there are any, might be for a downward surprise in the unemployment rate. Regarding the non‐manufacturing ISM, a stabilization at 56.3 is expected in June, after the index picked up sharply over the previous months. We continue to see upside risks. In the euro zone, retail sales are expected to have increased further in May. The consensus is looking for an increase by 0.3% M/M, but we believe that a weaker outcome is likely after strong data in the previous months.

In her speech before the IMF, Fed Chairwoman Yellen responded to criticism of the BIS that central bankers are skewed towards easing in their policy setting and don’t take financial risk into account when setting policy. Ms.Yellen said financial stability concerns shouldn’t prompt a change in current monetary policy. Supervision and macro‐prudential tools should be the main line of defence. Monetary policy faces significant limitations as a tool to promote stability.

Regarding the ECB meeting, we don’t expect new decisions following the package of measures taken in June. During the press conference, attention will go to further details on the TLTRO and ABS to eventual comments on the recent weaker eco data and the continuation of low inflation. The AQR and the frequency of the ECB meetings are other potential topics. All in all, we don’t expect much new from Draghi. His aim by taking several measures in June was to buy time. So, we expect him to be in holiday‐mood and side‐step hot topics.

Overnight, Asian markets trade sideways, as investors are side‐lined, waiting on the US payrolls report. Tomorrow, US markets are closed in observance of the 4th of July meeting. Today, there is already an early close in cash bond and in bond future markets. So, today’s price action will be very much concentrated on the immediate aftermath of the US payrolls release. Spain and France hold bond auctions (see calendar) and the ECB meets (see higher). Interesting, but for markets the payrolls dominate. So, we limit our observations to the latter. Consensus expects a net rise of 215 000 jobs, but following yesterday’s strong ADP report (281 000 extra private jobs) and the reaction, the whisper number should be higher, but not enough to invalid our rule of thumb that payrolls need to be about 50 000 off consensus to get a pronounced reaction. So, if payrolls grow by about 265 000 or more, US Treasuries should sell off. On the downside, Treasuries may already gain ground, if payrolls increase by less than 190 000. The reaction might a bit more pronounced if the unemployment rate would decline (in case of strong payrolls), or rise (in case of weak payrolls). We see risks for a somewhat stronger payrolls number, but not enough to satisfy our rule of thumb (265 000).

Technically, the reaction on the payrolls become relevant if the 10‐year yield moves above 2.66% and the Note future drop below 123‐25. In case of a strong report, we expect the 5‐year to underperform, as a strong report would affect interest rate expectations. For the Bund, it is still close to the highs, meaning that a sell‐off of US Treasuries shouldn’t affect the technical picture of Bund greatly (Main support at 144.45/03, 10‐year yield 1.44).