The US ADP employment report showed a slowdown in hiring in July

Rates

Yesterday, repositioning on global core bond markets initially continued though to a lesser extent than yesterday. Cease-fire rumours between Russia and Ukraine sparked volatility, but so far truce hasn’t been reached. So, initial losses were partly (Germany) to fully (US) recouped. The Beige book was marginally more upbeat than the previous one, but still points to moderate, but unexceptional, growth with little wage pressures. It allows the FOMC to taper again, but doesn’t necessarily incite the Fed to fasten its slow path to normalization of policy.

In line with the official payrolls report, also the US ADP employment report showed a slowdown in hiring in July. For August, a limited pick-up is expected. The ADP report is forecast to show an increase in private sector employment by 223 000 in August, up from 218 000 in July. Most recent US data have been quite strong, both survey data and initial claims. We believe therefore that the risks are for a stronger outcome, despite Tuesday’s warning by the NFIB. They suggested that hiring among SME’s almost came to a standstill in August, which is a wildcard for the ADP report. In July, the US non-manufacturing ISM jumped to a new post-crisis high, rising from 56 to 58.7. For August however, a correction is expected, to 57.6. We believe however that the risks remain for an upward surprise as we see no reasons for a worsening in sentiment in the non-manufacturing sector, especially not after the strong manufacturing ISM earlier this week. The US trade deficit is expected to have widened somewhat in July, following a significant narrowing in the month before. Initial jobless claims are forecast to continue hovering around the 300K.

For a full preview of the ECB meeting, see our flash report. Regarding the ECB decisions, we see a small chance that the ECB will lower the repo-rate to 5 bps and keep the depo-rate at -0.10%, as such a move would raise the attractiveness of the upcoming TLTROs. We see a bigger chance that they announce the (future) start of an ABS purchase programme in an attempt to kick-start this market which is in hibernation. It would also keep expectations alive that a full-blown QE programme might still be implemented if TLTROs and ABS don’t deliver the expected results in terms of credit easing and lending. We expect Draghi to be very dovish (downgrade eco assessment, promise to do “whatever it takes” ), but see nevertheless risks that he has to backtrack on some of his Jackson Hole comments (de-anchoring inflation expectations? fiscal comments?). Furthermore, the ECB staff projections for growth and inflation will likely show a downgrade for 2014 and maybe 2015, but the outcome for 2016 is less obvious. Conclusion, his Jackson Hole comments have raised expectations of bold action, but risks on disappointment are rather high. Uncertainties about the outcome of the meeting were maybe never as high as now.

The French treasury taps the on the run 10-yr OAT (1.75% Nov2024), 15-yr OAT (2.50% May2030) and 30-yr OAT (3.25% May2045) for a combined €8-9B. French auctions tend to go well and we don’t expect difficulties today either. The 10-yr OAT trades normal on the curve whereas the 15-yr and 30-yr OAT’s are a little rich. The Spanish debt agency sells the on the run 10-yr Obligacion (2.75% Oct2024) and 30-yr Obligacion (5.15% Oct2044) for €2-3B. The relatively low amount on offer should be easy to digest for investors. Spain is also well funded for the year, with +- 78% covered. Over the past week, the bonds didn’t cheapen going into the auction. The Oct2024 is a tad rich in the 10-yr sector. Overall, we still expect decent demand though given strong sentiment versus peripheral bonds. This week’s auction won’t be supported by bond redemptions.

Overnight, most Asian equity markets correct somewhat lower following past days gains. China outperforms though. The Bank of Japan made no changes to its aggressive monetary policy and said the economy was continuing to recover moderately. The US Note future trades stable, which resulted in an almost unchanged opening of the Bund.

Today, the calendar heats up with the ECB meeting and important US eco data (ADP & non-manufacturing ISM). In the run-up to the ECB, the Bund market is positioned for a dovish outcome. Regarding the decisions, we think that cutting the repo or not won’t have a big impact on the Bund. An announcement on ABS QE is discounted and should therefore not trigger additional gains. There may even some buy-the-rumour, sell-the-fact reaction. If the ECB endorses a broad-based QE programme, the Bund will revisit the highs. Overall, we fear that ECB Draghi won’t be able to live up to dovish expectations, in which case the Bund correction lower can be prolonged.

In the US, we see risks for stronger eco data especially after Tuesday’s impressive manufacturing ISM. Of late, the US Note future rallied in lockstep with the German Bund. We think it’s rather strange given the stronger economic recovery and difference in monetary policy (Fed vs. ECB). Losses for the US Note future after the ISM were small, but we hope to see a reversal in the Note future’s reaction pattern in case of robust reports today and tomorrow (payrolls).