The ECB will hold its weekly MRO tender

Rates

Yesterday, core bonds traded directionlessly in a tight range during the European opening session. Just ahead of the closure of the European session, bonds made one move higher on weaker equities, allowing them to eke out modest daily gains. We consider the price action as still corrective in nature and technically driven. Economic data were few and unable to give direction, even if weak US Existing Home sales and disappointing EMU consumption confidence were of course a positive. The testimony of Mario Draghi didn’t contain new key information. The German curve flattened with yields up to 4.4 bps lower.US yields shed up to 3 bps, the belly outperforming the wings.

Today, the eco calendar is interesting with the euro zone PMI’s, the Richmond Fed manufacturing index, US FHFA house prices and US Markit PMI. In August, the EMU PMI’s dropped significantly with the composite PMI reaching its lowest level since last December. Weakness was led by the manufacturing sector, while a more limited slowdown was seen in the services. For September, the consensus is looking for a stabilisation in the euro zone composite PMI at 52.5, while both the manufacturing (50.6 from 50.7) and services (53.0 from 53.1) PMI are forecast to show a marginal decline. We believe that the risks might be for an upward surprise as easing tensions in Ukraine and the ECB’s actions might have supported sentiment somewhat. In the US, the Richmond Fed index is forecast to have dropped slightly in September, after reaching a 3-year high. The consensus is looking for a drop from 12 to 10. We have no reasons to distance ourselves from the consensus. House prices are forecast to have picked up somewhat, while the Markit PMI is expected to stay broadly unchanged.

Fed Kocherlakota kept his ultra-dovish views intact when he spoke last night. Jobless rate overstates labour market strength and inflation will be below target in the next few years. He pleaded for a symmetrical attitude towards the 2% target and proposes that the Fed should specify the time horizon in which it will hit its inflation target. This would fight the perception of a lack of urgency from the Fed to fight too low inflation. So, Kocherlakota would be very cautious in raising rates and be more aggressive in guiding inflation higher towards its target. Another dove Dudley said that the below 2% inflation called for patience on rates. The rate guidance should be driven by economic data, while he favoured the economy running “a little hot” given low inflation. He downplayed the importance of the “dots”. On the other hand, he too (who not) would like to get off the zero-rate bound as soon as possible.

Financial stability is on the Fed’s radar, Dudley said, adding the Fed has changed how it views asset bubbles. Concluding, both governors want to go slowly on the lift off of rates, which is no surprise.

The US Treasury will start its end-of-month refinancing operation with a $29B 2-year Note auction. The ECB will hold its weekly MRO tender. Last week, banks asked for €82.6B TLTRO loans and announced to repay about €20B of LTRO loans. The combined effect is an expansion of liquidity by about €60B. Yesterday, excess liquidity was only €79.8B. Last week’s €105B MRO loan will be redeemed. After today’s MRO results we will have a good view on the liquidity conditions in the week ahead (see Sunset).

Overnight, most Asian equities trade positive with China outperforming despite WS losses. Japanese markets are closed. The Chinese HSBC manufacturing PMI came out slightly stronger at 50.5 and more PBOC easing rumours are on the wires. The US Note future trades flat, suggesting an unchanged opening for the Bund.

The EMU calendar heats up with a first estimate of EMU PMI’s. We believe that risks are on the upside of expectations. This is a negative for the Bund, though we believe that after last week’s intensive test, the downside is well protected around 147.92/63. In the US, Fed speakers line up with hawks Bullard & George and Powell. We especially look forward to governor Powell’s speech as he is part of a subcommittee within the FOMC on communications. They help the Fed frame and organize the discussion.
Recently, more and more governors for example hinted on leaving the “considerable amount of time” phrase in the Fed’s forward guidance.
Another proposal is twisting the statement so that it better reflects the US economic recovery and progress towards the Fed dual mandate. We hope to hear from Fed Powell how the debate is evolving. Hawkish elements are a negative for the US Note future, but the downside is protected short term.

Last week, the US Treasury market tested intensively yield resistance (5-yr: 1.85%, 10-yr: 2.66/69%), but could not break higher. This suggests that the down-move (prices) might be at least temporarily stopped. In this respect, we change our ST outlook to neutral from bearish for US Treasuries with a 123-10 to 125 ST trading range. For the Bund, support stands at 147.92/63 and if the uptrendline at 148.78 (under test) is recaptured, the next key resistance is the contract high at 149.91.