Balancing act for the ECB

Global core bonds ended close to unchanged yesterday. They lost ground during European dealings as stock markets recovered from opening weakness. An intraday turnaround occurred around the time when US Council of Economic Advisers Chair Hassett warned in a CNN interview for a very low Q1 growth number as a combination of typical Q1 weakness and the extended shutdown. He added though that it could be followed by a "humongous" Q2. Core bonds didn't find additional support from a swoon on stock and oil markets during US trading. A distorted EMU consumer confidence left no traces either. The German yield curve flattened with changes ranging between +0.8 bps (2-yr) and -1.1 bp (30-yr). The US yield curve steepened slightly, with changes varying between -0.3 bps (2-yr) and +0.2 bps (30-yr). 10-yr yield spread changes vs Germany ended close to unchanged with Greece (+6 bps) underperforming.

Asian stock market fluctuate between flat and +0.5% this morning. Core bond futures are choppy near yesterday's opening levels. We expect a neutral start for today's trading session.

Today's eco calendar heats up with EMU January PMI's and the ECB meeting. PMI's are forecast to stabilize after last year's nearly uninterrupted decline. Consensus expects a small uptick in the composite gauge, from 51.1 to 51.4. We side with these expectations. From a market point-of-view, it will be interesting to see the reaction in case of a positive surprise. Will investors already take it as a sign that global growth worries are somewhat exaggerated, pushing core bonds lower? The European central bank will keep its monetary policy unchanged this afternoon and refrain from downgrading its economic risk outlook. Click here for an extended preview. It will again be an exercise in linguistics for ECB President Draghi to avoid creating panic in either direction (amplifying growth slowdown woes or standing firm with policy normalization). Any hints on preparing for new TLTRO's is a wildcard and could support markets from a risk-on perspective (lower Bund & tighter peripheral spreads). Overall, in the above-plotted scenario, we expect a muted market reaction to today's events without technically significant moves.

From a technical point of view, the German 10-yr yield bounced off 0.15% support, but the picture didn't change yet. Therefore, the 10-yr yield needs to clear the 0.31% hurdle. The US 10-yr yield lost the 2.75%-2.8% area by the end of last year. This zone now works as resistance in a trading band floored by 2.5%. In both Germany and the US, we think that sufficient bad news is discounted at current levels. Policy normalization expectations in the US and EMU have become extremely/too dovish. However, a clear trigger is needed before declaring a sustained turnaround.

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