Overnight, Asian equities trade mixed

Rates

Yesterday, global core bonds were hit hard by a stronger than expected Q2 US GDP report. The FOMC statement, which was interesting (see below), couldn’t excite markets anymore, maybe because of the reaction on the GDP report. In a daily perspective, US yields were up to 9.7 bps higher, with the curve steeper till the 10-yr tenor. The 2-yr yield rose about 3 bps after the GDP release, but fell slightly back after the FOMC statement. Nevertheless it reached the highest level since mid-2011. In EMU, the German yield curve steepened with yields up to 6.2 bps higher. The 10-yr yield moved away from the historic lows and closed 5 bps higher. The 10-yr German/US yield spread widened again to 138 bps, setting a new cycle high. However, yesterday’s price action confirmed that German bonds remain sensible to events in the US Treasury market. That relationship weakened in past months. On intra-EMU bond markets, yield spreads (10-year) barely moved.

Today, the focus will be on the EMU unemployment rate and inflation data, while in the US only the jobless claims and Chicago PMI will be released. In the EMU, inflation is expected stay unchanged at its 4,5-year low of 0.5% Y/Y in July. Recently, euro zone inflation is showing signs of bottoming out, but we believe that a limited further drop is not excluded. Yesterday, German HICP inflation came out in line with expectations, falling from 1.0% Y/Y to 0.8% Y/Y. In Spain, inflation surprised on the downside falling to -0.3% Y/Y from 0.1% Y/Y. Also for the euro area, there are potential downside risks, even if we take into account upward risks stemming from positive base effects in Italy. Also in the euro area, the unemployment rate is expected to stay unchanged at 11.6% in June. As the unemployment rate seems to have started a very gradual downtrend, we believe that there are downside risks. In the US, jobless claims dropped last week to a new multi-year low of 284 000. For the week ending the 26th of July, the consensus is looking for an uptick to 300 000. The claims might have been distorted last week due to automotive shutdowns. As factories are starting to reopen, volatility will probably remain high and therefore we believe that an upward surprise is not excluded. Finally, the Chicago PMI is expected to show a limited uptick in July, from 62.6 to 63, following a significant drop in June.

Regarding the FOMC meeting, we retain that the Fed is more optimistic on economic growth and on the labour market, while it is less concerned about too low inflation. It cut as expected its QE programme by another $10B, but left its current policy orientation intact. Governor Plosser dissented against the guidance which according to him does not take the registered improvement in the economy into account. The market reaction was subdued. We think that with these subtle changes, the FOMC is moving closer to the normalization of policy, even if the FOMC did nothing to change the consensus view that they will move only very slowly. For a full review, see our flash report.

In the US, the Treasury concluded its end-of-month refinancing operation with a sloppy $29B 7-yr Note auction. The bid cover wasn’t bad, but the auction had a full bp tail. The overall buy-side figures were about average due to a good Indirect takedown, but a weak Direct bidder takedown. The auction followed a weak 2-yr Note auction on Tuesday and a good 5-yr Note auction yesterday. Additionally, the Treasury also conducted a plain vanilla $15B 2-yr FRN auction

Overnight, Asian equities trade mixed. Just like US stocks, they don’t really know what to do with the Fed’s modestly more upbeat assessment of the economy. Japanese wage growth unexpectedly slowed while housing data were mixed. There’s no underperformance of Japanese stocks though. Finally, S&P declared Argentina in default after the government missed a deadline for paying interest on restructured bonds. Overnight, the US Note future trades stable.

Today, the eco calendar is less interesting than yesterday. The eye-catcher is the EMU inflation number. A stabilization at 0.5% y/y is expected with risks slightly skewed to the downside. In theory that’s a positive for the Bund though in light of last week’s strong PMI readings and yesterday’s sell-off on better US eco numbers we think any upside is limited especially ahead of the US payrolls report tomorrow. The US calendar contains weekly claims and Chicago PMI. Following yesterday’s slightly hawkish FOMC statement, we look out whether bond markets become more sensible to (better) US eco data.

Last week we changed our short term view to a sell-on up-ticks, preferably near the highs, as investors might have underestimated the signal from better EMU PMI’s.