Consolidation ahead of Fed meeting?
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Volatility after payrolls short-lived
Global core bonds trading showed some intraday volatility on Friday, but eventually closed near opening levels. Weakness ahead of the US payrolls on positive risk sentiment was undone after the US labour market report. Net job creation remained strong and the unemployment rate remains at the lowest level since 2000, but earnings disappointed. The market reaction proves sensitivity to price/inflation data. The scale of the move remained limited though with Wednesday's Fed meeting looming. Investors don't want to be wrong-footed by a Fed who still intends to hike rates three times next year.
In a daily perspective, German yields increased by 0.8 bps (30-yr) to 2.3 bps (5-yr). The German 10-yr yield tested 0.3% support for a third straight day, but a break didn't occur. Changes on the US yield curve ranged between -0.8 bps (2-yr) and +1.3 bps (10-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany ended unchanged in the European (semi-)core. Peripheral spreads narrowed by 2 to 4 bps with Greece continuing to outperform (-28 bps) following a successful debt swap at the end of November.
Today's eco calendar is empty. The US Treasury starts its mid-month refinancing operation with a $24 bn 3-yr Note and a $20 bn 10-yr Note auction. The WI's are trading currently around 0.69% and 2.39%. The calendar heats up later this week. The Fed meets on Wednesday and is expected to hike its policy rate a third time this year by 25 bps to 1.25%-1.5% which completely discounted in markets. The new "dot plot" will receive most attention. We expect the central bank to stick to its intention to hike rates three times next year. Since September, (rate) markets for the first time this hiking cycle started aligning with the Fed's scenario. Past years, they were positioned much more dovish which proved right in 2015 and 2016. The market implied probability of a next rate hike (to 1.5%-1.75%) in March already stands at 60% with two hikes already discounted for 2018. The ECB meets on Thursday. An unchanged policy is expected after the announced decisions on APP in October. Draghi will face some questions on the future of the central bank's forward guidance as more and more ECB-governors question the need to link APP to the inflation outlook rather than monetary policy as a whole. However, he'll probably continue sounding dovish, pointing to lack of underlying inflation pressure. New growth and CPI forecasts (including 2020) could be crucial in determining the market reaction, if any.
Consolidation ahead of Fed meeting?
Risk sentiment is positive in Asia with China outperforming (1%). The US Note future and Brent crude are trading steady, suggesting a neutral opening for the Bund.
Today's eco calendar is empty apart from the start of the US refinancing operation. That could spark some underperformance of the US Note future vs the Bund, but we expect trading to occur within existing (sideways) ranges ahead of Wednesday's Fed meeting (see above). Volumes are expected to decline. Risk sentiment is a wildcard.
Technically, US Treasuries will probably trade in the 123-27 to 125-14+ range going forward (March 2018 contract!). This corresponds with a 2.3%-2.47% band in yield terms. The German Bund set a new contract high, but this wasn't confirmed by a drop of the German 10-yr yield below 0.3%, although the test is ongoing. We don't anticipate such move and suggest putting short positions around current levels. Strong current and expected growth and the ECB's slow normalisation process warrant such move.
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