Bear steepening core bond yield curves

On Friday, global core bonds lost some ground in the opening on the back of strong equity markets and higher Chinese CPI & PPI. Apart from positive risk sentiment, the UK Gilt market also fell prey to another selling wave, pulling Bunds and US Treasuries also slightly lower. All in all though it was mostly sideways trading. During US dealings, US retail sales printed in line with expectations though the control group, which is a proxy for goods consumption in US GDP, disappointed. US PPI data on the other hand, surprised on the upside of expectations. This mixed data picture caused some volatility on the US Treasury market, but ultimately T-Notes went higher to the openings levels, helped by a weak Michigan consumer sentiment. However, the tide turned and a sharp late session selling wave pushed core bonds lower again, sharply steepening the curve. Fed chairwoman Yellen played with the idea of allowing the US economy to run hot, suggesting that the Fed might tolerate somewhat higher inflation. Resistance levels at the 10-yr yield (1.75%) and 30-yr yield (2.5%) were broken.

In a daily perspective, the US yield bear steepened sharply with yields flat (2-yr) to 8.1 bps (30-yr) higher. The German yield curve shifted in similar but less outspoken way with yields flat (2-yr) to 3.1 bps (30-yr) higher. The US-German 10-yr yield spread (174 bps) nears the 2016 highs. On intra-EMU bond markets, 10-yr yield spread narrowed up to 2 bps with Portugal outperforming (-9 bps).

Focus on US manufacturing data

During the morning session, only the final Eurozone HICP inflation report for September will be released, but it won’t move the markets. During the US session, the NY manufacturing survey index is expected to show a marginal improvement in October to 1 from -1.99 in September and -4.2 in August. We side with the consensus for an improvement, but being only marginal above zero it still suggests sluggish activity. The September US production is expected to show a modest 0.2% M/M rebound following a 0.4% M/M decline in August, while manufacturing production should be up 0.1% M/M following a 0.4% M/M drop. Aggregate hours worked in the manufacturing fell 0.4% M/M in September, which suggests a decline of manufacturing output. Offsetting this will be an increase in mining output (as number of operating rigs climbed) and a rise of utility output (warm September). Nevertheless, all in all we see downside risks to the consensus.

German, Spain and France tap market

This week’s EMU bond supply is rather low, coming from Germany, Spain and France. On Wednesday, the German Finanzagentur taps the off the run 30-yr Bund (€1B 2.5% Aug2046). On Thursday, the French Treasury taps the on the run 5-yr OAT (0% May2021) and off the run OAT (3% Apr2022) for a combined €5-6B. The Spanish debt agency auctions the on the run 3-yr Bono (0.25% Jan2019), off the run Obligaction (5.9% Jul2026) and on the run 50-yr Obligacion (3.45% Jul2066). The amount on offer still needs to be determined. This week’s supply will be supported by a €18B Italian redemption.

US 10-yr and 30-yr yields advance further

Overnight, Asian stock markets trade mixed near opening levels. The US Note future and Brent crude trade stable, suggesting a neutral opening for the Bund.

Today’s eco calendar contains the final EMU inflation figure for September, US empire manufacturing and US industrial production. Risks for the latter are on the downside of expectations, but we don’t expect the data to influence trading. A speech by Fed vice-chair Fischer is a wildcard for trading. Overall we expect sentiment-driven trading on core bond markets. The current environment is not exactly bond friendly. US 10-yr and 30-yr yields broke above key resistance levels last week. The US Note future is still testing a key support area (see graph).

The Bund lost ground since the start of the month and now also approaches first support (lower bound trading range 163-162.56; 10yr yield 0.08%-0.10%). We expect more QE tapering rumours/fear in the run-up to this week’s ECB meeting, which should cap the potential of any upward corrections while we don’t expect technical breaks lower yet.

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