Slow start to trading week

Rates

The German Bund traded with an upward bias in an uneventful European session. A significant drop in the oil price and deteriorating sentiment on equity markets, triggered a minor safe haven bid for the Bund. The eco calendar was dead empty and US markets closed for Columbus Day Holiday. Traded volumes were extremely low, even for a Monday and could have magnified daily moves. In a daily perspective, the German yield curve bull flattened with yields 0.8 bps (2-yr) to 4.2 bps (15-yr) lower. On intra-EMU bond markets, 10-yr yield spreads versus Germany widened up to 12 bps (Greece).

Washington-based governor Brainard broke ranks with the other board members regarding the lift-off timing and more generally on the need to keep nurturing the US economy. She urged her colleagues not to prematurely withdraw monetary support given mounting risks globally and danger of low inflation. The Fed should watch and wait rather than tighten policy. Risks to growth and inflation are tilted to the downside. Risks to the near term inflation outlook are biased to the downside given the persistent low level of core inflation, falls in market-based inflation expectations and deflationary cross currents from abroad. She highlighted the danger that the Fed lifts rates only to find that it needs to lower them again. She referred to other central bankers (like ECB) who had increased rates only to lower them afterwards. She also distanced herself from Fed predictions that the tightening of the labour market is likely to feed through to higher wages and prices. “the classic Phillips curve influence of resource utilisation on inflation is, at best, very weak at the moment.” It looks clear that she is not in favour of the 2015 lift-off and 1 of the 4 governors that distances herself from the majority.

Well-filled eco calendar

In the US, the NIFB business sentiment is expected to drop from 95.9 to 95.3 (Sep). The NIFB release is no typical market mover, but given recent bad eco news, it will be interesting whether also smaller firms are becoming less confident. In the Eurozone, the German ZEW expectations index is expected to drop further down to 6.5 for October, coming from 12.1 previously. It would be the seventh consecutive monthly decline after last month’s significant drop from 25.0 to 12.1. Given the market volatility and the German turmoil with the dieselgate, we see risks on the downside of expectations. Also on the agenda are key quarterlies from Intel Corp, Johnson & Johnson and JPMorgan Chase.

The Netherlands and Italy kick off supply

Today, the Dutch debt agency taps the on the run 10-yr DSL (0.25% Jul2025) for €1-2B. The bond cheapened slightly going into the auction in ASW spread terms and trades relatively cheap at the long end of the Dutch curve. Overall, we expect plain vanilla demand. The Italian treasury launches a new 3-yr BTP (€3-3.5B 0.3% Oct2018) and taps the on the run 7-yr BTP (€2-2.5B 1.45% Sept2022) and 15-yr BTP (€0.5-1B 1.65% Mar2032). On the grey market, the new BTP offers a 1.8 bps pick-up in ASW spread terms compared with the previous 3-yr benchmark (0.25% May2018). That corresponds with a 5 bps pick-up in yield terms. The other BTP’s didn’t cheapen going into the auction. On the Italian curve, the 7-yr BTP trades normal while the 15-yr BTP is rich. We expect especially the 3-yr BTP auction to go well.

Today: Equity and commodity markets key

Overnight, the US Note future trades stable despite dovish comments by Washington-based governor Brainard (see above). ECB Mersch said that the ECB would act if the inflation outlook weakens. Sentiment on Asian equity markets is negative, with main indices up to 1% lower.

Today, US investors return from Columbus Day Holiday. The eco calendar contains German ZEW and US small business optimism, but we expect the outcomes to be near consensus. Therefore, evolutions on commodity and equity markets could be the main trading theme. Yesterday, the rebound of commodity prices halted with oil eventually even losing $3/barrel. A new slump in commodities is a positive for core bonds. Also the comeback of equity markets shows early signs of topping off. A correction lower should again be positive for core bonds, which held up well during the equity rally.

After the dovish September FOMC meeting, we eyed a return to the contract high for the US Note future (129-10+), but we didn’t anticipate a break higher. That last assumption was under severe pressure after disappointing payrolls, but ultimately both the US Note future and the Bund are back in the ranges. We hold our cautious sell-on-upticks approach for core bonds around current levels for return action to the lower bound of the established ranges, but are aware that a new slump in equity/commodity prices could interfere this scenario.

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