Will Bunds continue to decline as ECB meets?
|Global core bonds ended higher yesterday with German Bunds underperforming US Treasuries. German Bunds finally gave in to the uplift of risk sentiment after resilience of the previous days. The German yield curve moved higher with the belly of the curve underperforming. Changes range from +3.2 bps (30-yr) to +4.7 bps (5-yr). The US yield curve edged up as well with changes from +0.8 bps (2-yr) to +3.1 bps (10-yr). Italian BTP’s rallied after the Italian government reached an agreement to lower its budget deficit to a manageable 2.0%. The Italian 10-yr yield fell below 3.0% for the first time since September. The Italian/German 10-yr yield spread decreased 17 bps to 272 bps.
Asian markets this morning show the uplift in sentiment continues today with all equity indices opening in green. China outperforms its peers on a first (practical) sign that the US and China are genuinely working on a trade deal as Chinese food importers have bought US soybeans for the first time in months. US Treasuries opened neutral with a small desire to continue the downward trend of late. We expect a similar opening for the Bund, with investors eying the ECB’s rate decision this afternoon, followed by president Draghi addressing the public. The ECB fixed the guidelines of its policy at the June meeting. Policy rates are expected to remain unchanged at least through the Summer of 2019, net asset purchases will end by the turn of the year and the reinvestments of maturing bonds from the APP portfolio will last as long as deemed necessary. Focus will be on president Draghi’s comments afterwards. We expect that the ECB will downwardly adjust its growth/inflation forecasts, but Draghi will try to keep a balanced message to avoid large market swings. He recently fiercely defended the view that underlying inflationary pressures are building because of rising wages, a closing output gap and the ECB’s very accommodative policy. Investors will also be looking for new hints on a possible new round of TLTRO’s. From a market point of view, it’s probably hard for Draghi to surprise of the dovish side of current positioning. We expect any market impact to be small whatsoever.
From a technical point of view, 0.18% (German 10y yield) and 2.78/2.8% (US 10y yield) are the lines in the sand. A break lower would, especially in the US and taking into account the inversion at the 2y-5y, signal heightened fears of a nearby end to the economic & monetary cycles. For now, our hypothesis remains that the correction on rate markets the past month resulted in a too dovish positioning going into the final ECB & Fed meetings of the year.
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