Can Draghi keep quiet?
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Core bonds rally runs out of steam ahead of ECB
Yesterday, the two-day core, counter-trend, bond rally ran out of steam around European noon. Volumes traded in the Bund and the T-Note contract were well below average. The intraday price action was unrelated to equities and oil. Euro area data were second tier and US housing starts and permits mixed. The Fed's Beige Book showed slightly stronger conditions and pointed to election uncertainty. In a daily perspective, German yields ended 0.2 bps higher (2-yr) to 1.2 bps (30-yr) lower. Changes on the US yields were of similar magnitude: 0.4 bps lower (2-yr) to 0.4 bps (10-yr) higher. On intra-EMU bond markets, 10-yr yield spread changes versus Germany closed nearly unchanged, except for the ongoing outperformance of Portugal (-5 bps). DBRS will give its rating verdict on Friday.
ECB meeting and US eco data eye-catchers of the day
There are still a lot of uncertainties in the euro area, UK and elsewhere, which may affect monetary policy, if they lead to destabilising outcomes-as has been the tendency in recent years. However, we think that markets are beginning to consider whether monetary policy has now reached a turning point. Change will be very gradual though and become only visible after some time. Fiscal policy will become the focus of efforts to push inflation higher. Inflation expectations show tentative signs of such a development as does the steepening of the yield curves. In this context, we think markets could move away from any expectation of another rate cut and begin to focus instead on the possible implications of the ECB announcing a reduction in the amount of its asset purchases. This should steepen the curve further in the euro area. For today though, we don't expect any concrete signal from the ECB or Mario Draghi. They bought time tasking the ECB Committees with evaluating options to ensure "a smooth implementation" of the asset programme. We expect communication in December. For a full preview of the ECB meeting, see our Flash report.
US initial claims are expected to have slightly risen to 250K for a very low 246K in the previous two weeks. Claims continue to surprise on the downside, but given the very low levels we would indeed expect a slight increase in the past week. The Philly Fed manufacturing sentiment index surpised in September by jumping to 12.8 from 2 in August. However, the details showed a much more mixed picture. Therefore, we think that the index will drop in October, but still stay in positive territory. Finally, the Existing home sales are expected to be marginally higher in September at 5.35M, up 0.4% M/M. That would leave the upwarde trend intact, even as the highs were reached in June at 5.57M.
Spain and France complete this week's issuance
The French Treasury taps the on the run 5-yr OAT (0% May2021) and off the run OAT (3% Apr2022) for a combined €5-6B. The bonds didn't cheapen in ASW spread terms going into the auction. On the French curve, the May2021 OAT trades cheap while the Apr2022 OAT is expensive. The auction will be supported by a French OAT redemption (€26B) next week. Additionally, the French treasury aims to raise €0.5-1B via inflation-linked bonds. We expect the French auctions to run smooth, especially given the relatively low amount on offer. The Spanish debt agency auctions the on the run 3-yr Bono (0.25% Jan2019), off the run Obligaction (5.9% Jul2026) and on the run 50-yr Obligacion (3.45% Jul2066) for a total amount of €3-4B. The Jul2026 and especially Jul2066 Obligacions cheapened in the run-up to the auction in ASW spread terms and the Jul2026 bond trades really cheap on the curve. The auction could also already get some support from an upcoming redemption at the end of the month. We expect the auctions to go well.
Can Draghi keep quiet?
Overnight, Asian stock markets eke out small gains with Japan outperforming on the back of a weaker yen. After the final presidential debate, Clinton remains in pole position to secure the job which slightly supported sentiment. The US Note future and Brent crude trade stable though and we expect a neutral opening for the Bund.
Today's eco calendar contains some US eco data, but attention will turn to the ECB's policy meeting. We expect an unchanged policy decision while Draghi will probably try to duck any question about the end of QE. Technical committees are studying the ECB's options and will report back by December. Any hint or mentioning of a future end of QE will trigger more nervousness/weakness at the long end of European yield curve. Technical support levels in the Bund (163) and US Note future (129-26) held earlier this week, but could come back in play in such scenario. If Draghi manages to stay neutral, we don't expect much reaction in the Bund.
In yield terms, the US 10-yr yield (1.75%) and 30-yr yield (2.5%) broke above important resistance levels last week. We are currently testing those levels again, but from a support point of view. If we manage to stay above them, it would send an important technical signal that (long term US yields could rise further).
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