Counting down to ECB meeting
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Hardly negative impact from Italian referendum
Yesterday, global core bonds initially lost substantial ground, but managed to recoup the largest part during US trading. Several factors probably played a role in the selling. First, the adverse outcome of the Italian referendum was by and large expected/discounted. Second, the FT ran several articles suggesting the ECB would be less soft, at its meeting on Thursday, than generally expected. Third, oil prices reached their highest level since July 2015 ($55/barrel) and inflation expectations (5y5y forward swap) added another 2/3 bps, extending their upward trend. EMU eco data (weaker final November EMU services PMI and stronger October retail sales) had no impact. The US non-manufacturing ISM printed very strong at 57.2, pushing US bonds to intraday lows, after which short covering started. US volumes were moderate, while Bund volumes were high (contract roll). Fed governors Dudley and Evans, both rather dovish, indicated that the Fed is ready to hit its dual mandate and favour a tighter US policy over time. The technical pictures of the German bonds and most US Treasuries didn't change.
In a daily perspective, changes on the US yield curve (bear flattening) ranged between 0.2 bps (30-yr) and +2.4/2.5 bps (2 & 5-yr). German yields changes varied between 2.7 bps (2-yr) and 5.1 bps (10-yr). On intra-EMU bond markets, 10-yr yield spreads versus Germany narrowed 4/5 bps for Spain and Portugal and 2 bps for Austria (election outcome). The Italian underperformance (+3 bps) was limited given the referendum outcome. Rating agency DBRS warned that the referendum outcome is credit negative. A DBRS downgrade would also downgrade the value of Italian bonds as collateral. If sentiment versus Italy deteriorates further, it could complicate capital operations at several Italian banks with BMPS rumoured to be heading to a state bailout.
Thin calendar with little market impact?
The Euro area calendar contains the final Q3 GDP figure. No changes are expected and it is outdated. The US calendar is better filled, but barely more interesting. The October trade deficit is expected to have increased to $42B from $36.4B in September. The deterioration has already be signaled by the advance goods trade balance report. The service trade surplus is expected to have broadly stabilized. The bigger overall deficit suggests that net trade will weigh on Q4 GDP. However, it's only the first figure for the quarter and the balance is quite volatile on a monthly basis.
The factory orders are expected to have rebounded in October based on an already reported improvement in the durable orders and increases for non-durables like petroleum. Neither the trade balance nor the factory orders should give the market firm direction.
Counting down to ECB meeting
Overnight, most Asian equity markets trade positive, eking out gains of up to 1.5%. Brent crude trades stable near the recent highs around $54.50/barrel and the US Note future also suggests a neutral opening for the Bund.
Today's and tomorrow's eco calendar is uninspiring for core bond trading which means that investors will start counting down to Thursday's ECB meeting. Latest press articles suggested that the central bank will be less soft than generally expected. That could keep the Bund in the defensive or neutral going into the meeting. Oil prices and inflation expectations remain wildcards for intraday trading.
Technically, the US 2-yr yield broke above 1.1% resistance. The US 5-yr yield tries to break above the 1.85% area, while a first test of 2.5% resistance in the US 10-yr yield failed. The US 30-yr yield remains below a similar 3.25% mark. We wait for specific news (e.g. a hawkish Fed next week) before anticipating a break higher (5yr & 10 yr). We hold our sell-on-upticks approach in US Treasuries.
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