German 10-yr yield below key support

Global core bonds eked out more gains today. The dovish bias of global central banks continues to underpin both the Bund and the US Note future. ECB Praet said that there are no taboos in the ECB’s effort to lift inflation, further suggesting that the ECB will take additional easing action in December. Also ECB Nowotny rang the alarm bells on the ECB’s inflation mission. The German 10-yr yield declined below 0.5% to the lowest level since May. Final technical support before the all-time lows stands at 0.43% (62% retracement from April to June up-leg; see graph). Most important US eco data disappointed (durable goods orders, consumer confidence), but core bonds didn’t additionally profit, even if it increases chances that the Fed lift-off will be postponed into 2016. In a daily perspective, the German yield curve bull flattened with yields 1.4 bps (2-yr) to 7.1 bps (30-yr) lower. Changes on the US yield curve were much lower. They fell between -1.6 bps (2-yr) and -3 bps (5-yr). The belly of the curve outperformed the wings. On intra-EMU bond markets, 10-yr yield spreads versus Germany widened marginally with Portugal and Greece (+ 7/8 bps) underperforming.

Today, the market calendar contains the FOMC’s rate decision , but also Sweden and New Zealand decide on monetary policy. The Swedish Riksbank is expected to hold its policy rate at -0.35%. However, 2 out of 18 analysts already expect a further rate cut. Pressure of the ECB might push the Swedes to move further down. The RBNZ also decides on its interest rates tonight. The majority expects the interest rate to remain unchanged at 2.75%, although a 4 out of 18 analysts foresee a rate cut.

We expect the Federal reserve to leave policy unchanged. Market chances for a rate hike are only 4%. The Fed needs more information, which it doesn’t have at this juncture. Eco data have been weak since the previous meeting, suggesting that the US economy is cooling down. A soft patch or a more malign downturn? More information is needed. Since the September meeting, a number of governors, including two board governors Brainard and Tarullo, feared that inflation wouldn’t move fast enough to the target in the medium term, questioning the relationship between full employment, higher wages and ultimately higher inflation (Phillips curve). They suggested that the lift-off might better be postponed until signs of wage inflation became visible. This in fact questions the reaction function of the Fed, as perceived by the Fed chair and vice-chair. So, markets are confused by the Fed’s policy. We will closely look how the Fed perceives recent weak payrolls and whether they still support Yellen’s reaction function, which implies that in case of stronger labour market conditions, one should not wait to see inflation actually going up before raising rates. However, the press release will admit the weaker data in its first paragraph, but it is unlikely that the FOMC will give already further more concrete guidance about the timing/conditions for the lift-off.

More weakness in German primary auction?

Today, the German Finanzagentur taps the on the run 10-yr Bund (€3B 1% Aug2025). Total bids at this year’s Bund auctions averaged a meagre €3.29B. On two occasions, they even fell below €3B. In the run-up to the auction, the Bund cheapened marginally in ASW spread terms. On secondary markets, sentiment for German bonds is positive in the current climate, but that doesn’t necessarily bode well for primary auctions. So overall, we fear another weak German auction. In the US, the Treasury holds a $15B 2-yr Floating Rate Note auction and a $35B 5-yr Note auction.

Today: Dovish Fed statement?

Overnight, Asian stock markets trade slightly lower with China underperforming and Japan slightly outperforming. The US Note future trades stable. Congressional leaders and the White House agreed on a budget deal that suspends the debt limit until March of 2017. This takes away an event risk, but markets didn’t seem to worry. ECB Coeure said that the ECB may need to cut its deposit rate further, confirming the recent very dovish central bank rhetoric. Overall, we expect a neutral to slightly positive opening for the Bund.

Today’s eco calendar is apart from the Fed meeting (see above). We expect the statement to include recent downbeat economic developments, which would further put in doubt a December lift-off. That’s a short term positive for US Treasuries. Dovish comments by ECB-members underpin EMU bond markets. Commodity prices are again sliding towards the recent lows, which underpins bonds further. Main equity indices remain a wildcard. The ECB’s very dovish message easily pushed EMU and US equities above important resistance levels, marking an end to the downward correction from a technical point of view. If risk sentiment further improves (eg on dovish Fed statement), that could hamper more gains for core bonds.

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