Core bonds open week strongly on risk off sentiment

The Bund opened strong following a long weekend, as risk aversion reigned following developments in Spain and Greece. Spanish regional elections showed increasing support for the Podemos-party, the Spanish “equivalent” of the Greek Syriza-party. The Greek newsflow was negative too (see Sunset yesterday). On intra-EMU bond markets, 10-yr yield spreads versus Germany widened 17 bps for Portugal, 14 bps for Italy and 9 bps for Spain. Greece underperformed (+50 bps). Amid an empty eco calendar, the Bund rallied further during the first trading hours but failed to take out the 154.97 resistance (38% retracement from May sell-off). The failed test triggered return action towards opening levels, but in later US trading, the Bund moved again somewhat higher, closing at 157.71, a 71 ticks gain. US Treasuries outperformed. Safe haven demand played a role too. The initial dip on the stronger durables was washed away fast. Mid-morning data (consumer confidence, Richmond Fed, New Home sales) were all a bit stronger than expected but offset by weakness in equities and some short-covering. The strong 2-year Note auction supported the better tone. In the end, the German yield curve bull flattened with yields between 1.2 and 5.8 bps lower. The US curve shifted in a similar way with yields up to 8.6 bps lower.

Unexciting calendar; little news from central banker

After a well-filled calendar yesterday, the eco calendar is thin today with only some national data in the euro zone, while the US eco calendar is empty. G7 Finance Ministers and Central Bankers meet in Dresden and Norway (Bond), Germany (Bund) and the US (5Yr Notes & 2Yr FRN) will tap the market. Bank of Canada decides on rates, but no change is expected.

Yesterday/overnight some central bankers spoke. Fed Lacker, a traditional hawk, said it was pretty clear inflation was heading back to 2%. He was divergence in weakness in spending data, but strength in the labour market.
Lacker said he hadn’t made up his mind on a June lift-off, but sees risks in moving too late. Fed Vice chairman Fischer said that the Fed will take the global economy in consideration as they start raising rates and thus should raise rates more gradually should the world economy falter. Nice comments of both, but nothing new and decisive regarding the policy outlook. ECB Visco said that risks for deflation have receded, as he sees signs of improvement in credit, but the ECB should complete its programme. Furthermore, he spoke especially about some problems of the Italian banking sector.

Will Portuguese auction do well after spread widening?

The German Finanzagentur taps the on the run 30-yr Bund (€2B 2.5% Aug2046). At the previous 4 long Bund auctions, total bids averaged only €1.91B. In the run-up to the auction, the Bund didn’t cheapen. Overall, we expect demand to remain low for this very long bond. The Portuguese debt agency taps the off the run PGB (3.85% Apr2021) for €0.75-1B. The bond cheapened going into the auction and trades relatively cheap on the curve. We expect the auction to go well, despite yesterday’s overall widening.

In the US, the Treasury started its end-of-month refinancing operation with a decent $26B 2-yr Note auction. The auction stopped just below the 1:00 PM bid side with an average bid cover (3.40). Bidding details showed both good direct and indirect bids while the dealer bid was scarce. Today, the treasury auctions a $13B 2-yr floating rate note and a $35B 5-yr Note. Currently, the 5-yr WI is trading around 1.535%.

Today:

Overnight, Asian stock markets trade mixed with no real market driver.
Chinese industrial profits and Japanese small business confidence didn’t impact markets. The US Note future trades intra-day a tad higher.

Today, the eco calendar is empty which means technical factors will be at play. It’s hard to tell which one takes the upper hand (technical levels, end-of-month extension buying, upcoming supply, risk sentiment). Greece and its creditors play down fears of an imminent default, but that’s unlikely to trigger a sudden change in sentiment versus Greece. All in all we hold a neutral approach for today’s trading. Risks if any, would be for a persistence of risk-off sentiment with new tests of key resistance levels.

Yesterday, the Bund tested 154.97 resistance (38% retracement of sell-off). A break higher would make the picture more bullish. In the US, the Note future approaches the upper bound of the sideways range (128-04+/12 and 126).