The risks might be for a slightly weaker outcome

Rates

Yesterday, global core bonds were hard hit and closed substantially lower. Both the German and US yield curve bear steepened significantly. German yields are 1 bp (2-yr) to 6 bps (30-yr) higher. In the US, yield changes range between +3.6 bps (2-yr) and +9.6 bps (30-yr). The 10-yr US-German yield spread widened to a 149 bps cycle high. On intra-EMU bond markets, there is a small outperformance of the periphery. Sellers were in the driver’s seat today. There were no important eco releases in EMU, neither key headline news to explain the decline of the Bunds. We think that repositioning ahead of the ECB was the main factor, as the Bund climbed relentlessly in past weeks, straight into overbought conditions. The US Note future corrected lower as well, especially before the ISM release. The latter was very strong, supporting the idea that the US economy is doing very well and stoking the debate about the normalization of Fed policy. After the ISM release, the extra losses were small. Nevertheless, it makes the bond bulls nervous and suggests that other eco data this week may be strong too.

Today, the eco calendar contains the final reading of the euro zone services PMI for August, the euro zone retail sales and US factory orders. Germany (Bobl) and Sweden (Bonds) will tap the market and the Fed will release its Beige Book. We expect the Beige Book to paint an optimistic picture of the US economy in line with the published eco data. This will lead to the next tapering and to the continuation of the debate on normalization at the Sep. 17 FOMC meeting.

According to the first estimate, the euro zone service PMI weakened from 54.2 to 53.5 in August, after reaching a 3-year high in July. The final reading is forecast to confirm this outcome. The risks might be for a slightly weaker outcome as heightened geopolitical tensions and increasing uncertainty might weigh more on sentiment. The more domestically-oriented services sector should however be less vulnerable that the manufacturing sector, which is internationally oriented. Also in the euro area, retail sales are forecast to have dropped slightly in July following three consecutive monthly gains. The consensus is looking for a decline by 0.3% M/M. We believe that risks are for a weaker outcome especially after poor German retail sales data, while also Spanish retail sales dropped during the month. Finally in the US, factory orders are forecast to show a 10.9% M/M jump in August mainly due to a very strong (318% M/M) increase Boeing orders. As durable orders are already available, especially the development in non-durables will be interesting, which are forecast to show a limited increase in August.

The German Finanzagentur launches a new on the run 5-yr Bobl (0.25% Oct2019) for €5B. The bond will most likely yield the lowest ever at an auction. Grey market trading indicates that the bond trades around 1 bp cheaper in ASW spread terms compared to the previous 5-yr benchmark (0.5% Apr2019). This corresponds with a 6 bps pick-up in yield terms. In absolute terms, the record low yield is hardly attractive, though ECB easing expectations and geopolitical issues could still support the bid. Portugal announced the launch of a new 15-yr benchmark (Feb2030) via syndication yesterday. The bond is expected to be launched and priced today, subject to market conditions. It’s the first new 15-yr PGB since June2008. Initial price takings are in the MS +240 bps area. Year-to-date, Portugal completed around 75% of this year’s funding.

Overnight, most Asian equity markets extend gains. Australian Q2 GDP was marginally stronger than expected, Chinese services PMI’s printed strong and the anticipated Japanese cabinet reshuffle came into effect. Geopolitical developments were less positive, with the beheading of a second US journalist by IS and the west considering more penalties against Putin.
Nevertheless, the US Note future ticks marginally lower suggesting geopolitical issues are not dominating currently.

Today, the calendar contains only second tier data with final EMU services PMI’s, outdated EMU retails sales and US factory orders. We don’t think that they will impact intraday trading. Yesterday, we had a nice repositioning move into the ECB meeting and US payrolls. Overbought conditions are now shrugged off. We think that this repositioning move still has potential to go somewhat further today though it should be less forceful than yesterday. Geopolitical tensions remain a wildcard for this strategy.