Hawkish Fed and sell-off at long end?
|Core bonds lost ground yesterday with US Treasuries again underperforming German Bunds ahead of today’s FOMC meeting. Last minute positioning suggests that (US) investors don’t want to be wrong‐footed by a potentially more hawkish Fed. Rising oil prices (Iran deal at risk?) weighed as well. Stock markets stabilized after Monday’s heavy selloff, but we didn’t find the rebound convincing. Disappointing German ZEW investor confidence also helped explain the Bund’s resilience compared to the US Note future. The US yield curve bear steepened with yields 3.7 bps (2-yr) to 4.4 bps (30-yr) higher. The US 2‐yr yield reached a new cycle high (highest level since 2008). Changes on the German yield curve ranged between +0.3 bps (30‐yr) and +1.6 bps (10‐yr). Peripheral yield spreads vs Germany narrowed 3 to 8 bps (Italy).
The US Note future has a marginal upward bias overnight. Asian stock markets rebound in line with WS. We expect a neutral opening for the Bund. Today’s trading session will probably be range bound ahead of the FOMC meeting. The Fed will hike its policy rate, but we also expect changes to the dot plot. More specifically, we expect a higher estimation of the neutral rate (3% from 2.75%) and a potential shift already in 2018 (4 from 3) and/or 2019 dots. Markets partly frontrunned on the short term shift, but don’t anticipate a higher neutral rate. Therefore, we mainly expect a sell-off a the longer end of the US yield curve. The Fed’s gradual lowering of its neutral rate from 4.25% in 2012 to 2.75% worked as a cap above the US 10-yr yield. Reversing these dynamics lifts scope for higher long term yields, especially if we add the prospect that the US’ fiscal policy will lead to a significant increase in twin deficits in the longer run. Technically, 3.07% is KEY resistance. A higher neutral rate suggests that we might go for a test in coming days. Medium term, we position for a break higher.
General geopolitical sentiment remains a short term wildcard via safe haven flows if it translates into uncertainty on stock markets. Investors fear a hawkish shift on Iran policy at the Saudi/US Summit, the US government faces a government shutdown on Friday and Trump adds to his protectionist rhetoric with more trade actions directed to China.
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