Bear steepening despite lower oil and equities

Rates

Global core bonds defied traditional trading wisdom yesterday by declining in lockstep with oil prices (Brent crude <$50/barrel) and stock markets. The move occurred amid a thin eco calendar and in absence of headline news. EMU and US supply was negative at the margin. Key support levels in the Bund (163 area) and US Note future (129-26) were tested (Bund) or again within reach (T-Note). We think that rate markets become enthralled by the recent change of tone of central bankers and rising inflation expectations. The market implied probability of a December Fed rate increased above 70%, ECB president Draghi laid the foundation of QE tapering and the BOE changed its intentions about additional easing this year. The US Markit services PMI surprised on the upside and the US trade deficit was much smaller than expected in September, suggesting that GDP may be a bit higher than expected. These data were bond-unfriendly, but published when the intraday sell-off was mostly done. US New Home sales rose by 3.1% in September, but after sizeable downward revisions in the previous two months.

In a daily perspective, the German yield curve bear steepened with yields 1 bps (2-yr) to 7 bps (30-yr) higher. The US yield curve shifted similarly, but with yields only 1.6 bps (2-yr) to 4.3 bps (30-yr) higher. On the UK curve, the 2 and 5-yr yield were 2.1 and 4.7 bps higher on Carney’s inflation comments. On intra-EMU bond markets, 10-yr yield spread changes versus Germany ranged between -4 bps (Portugal) and +2 bps (Italy) with Greece outperforming (-14 bps).

Eco calendar thin

In EMU, the releases are limited to the September M3 money supply figures. The markets expect a stabilization at 5.1% Y/Y. Already for 18 months M3 supply hovers between 4.5 and 5.1% Y/Y, a level accetable for the ECB. Markets will look to the lending data, but usually don’t react to the report In the UK , the advance Q3 GDP will be released (0.3% Q/Q), which may cause ripples in euro markets too in case of surprises. In the US, the durable goods orders and the initial claims will get attention. Claims are expected to have dropped to 255K from 260K in the previous week when claims jumped 13K albeit from record low levels, probably due to huricane Matthew. Durable goods orders are expected flat for September following a 0.1% M/M increase in August. It is a volatile series, but overall orders remain tepid. Capital goods shipments (nondefence), a source for GDP business investment is expected up 0.4% M/M following 4 monthly declines.

Average demand for US supply

The US Treasury continued its end-of-month refinancing operation with an uneventful $15B 2-yr FRN auction and an average $34B 5-yr Note auction. The 5-yr auction stopped right on the 1:00 PM bid side with a just above average bid cover (2.49). Bidding details were run-of-the-mill. Today, the US Treasury ends its operation with a $28B 7-yr Note auction. Currently, the WI trades around 1.61%.

Sentiment on bond markets soured

Overnight, most Asian stock markets lose ground while oil prices remain under downward pressure. However, in line with yesterday, the US Note future also declines and even tests 129-26 support suggesting that negative sentiment on core bond markets could continue today with the Bund also testing the 163-162.56 support area.

Today’s calendar contains amongst others UK Q3 GDP data and US durable goods orders. Exceptionally, core bond markets could pay more attention to Scandinavian central bankers with policy meetings in Norway and Sweden. Both countries have an extraordinary easy monetary policy despite strong underlying growth and even picking up inflation. If also the Riksbank and Norges Bank signal a shift in policy ahead (in line with similar messages from ECB, BoE and Fed; see above) it could intensify the sell off on core bond markets, preparing for a normalization of yields.

Technically, the US 10-yr and 30-yr yields held above key resistance levels at 1.75% and 2.5%, suggesting that the US Note future could break key support levels in the run-up to next week’s FOMC meeting, anticipating a clear hint on a December rate hike. The German 10-yr yield tested the 0.10% resistance a second time yesterday. A break higher would be very relevant from a technical point of view and unlock a new trading range (0.10%-0.30%). Rising inflation expectations and an expected ECB QE tapering announcement in December could do the trick.

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