BoE meeting and ECB speakers

Rates

US Treasuries' losses largely erased after dovish FOMC

Yesterday, global core bonds lost ground intraday, but recouped most of the losses after the FOMC statement. The Bund opened weaker on the back of improving risk sentiment in Asian trading. Gradually rising European equity and oil prices weighed on Bunds throughout the session. A stunning US ADP employment report and a very strong manufacturing ISM (with a skyrocketing price index), added another blow to US Treasuries and Bunds. Finally, the FOMC published a dull statement ( see flash report ).

As markets expected something slightly more hawkish, US Treasuries reacted in a dovish way, erasing a large part of the intraday losses. In a daily perspective, US yields ended between 0.8 bps (2-yr) and 1.7 bps (5-10-yr) higher. The German yield curve (cash market closed ahead of FOMC meeting) bear steepened with yields up to 5.7 bps (30-yr) higher. Please note that the 3-to-5-yr German yield changes (+7 to +10.9 bps) were partly due to benchmark changes. The German 2-10-yr yield spread reached 118 bps, the highest level since July 2014. The improving economic EMU environment and rising inflation expectations play a major role in the steepening. On intra-EMU bond markets, 10-yr yield spread changes versus Germany widened up to 2 bps with Spain (5 bps) underperforming on upcoming supply.

 

BoE meeting and ECB speakers

The BoE meets today, but no change of the policy stance is expected. Rather subdued headline inflation gives them leeway to stay soft. Nevertheless we don't expect the asset purchases to be prolonged beyond the original amount which is almost reached. This should be no surprise either, but it is another central bank that stops buying assets and thus may have some impact on sentiment. Markets will closely look to the revision of growth and inflation projections. If there would be a surprise, it could also affect sentiment on the other European bond markets. ECB Draghi, Praet and Coeuré will speak today. We suspect that after the strong eco data, the unexpected sharp rise of headline inflation and criticism of various governors, the Executive board might feel the need to confirm that their APP programme remains on track. They will point to subdued core inflation. In the past, when headline inflation was too high and core within the objective, the ECB often raised rates arguing that headline inflation influences with a time lag core inflation. Of course, those were different time.

 

France and Spain supply markets

The French treasury taps the on the run 10-yr OAT (0.25% Nov2026) and 15-yr OAT (1.5% May2031) for a combined €6-7B. Both bonds cheapened in the run-up to the auction is ASW-spread terms. The May2031 OAT is rather expensive on the French curve. We think that investors will use the recent politics-related French underperformance to snap up some bonds, suggesting a good auction. The Spanish Tesoro taps the on the run 3-yr Bono (0.25% Jan2019), 15-yr Obligacion (1.95% Jul2030) and off the run Obligacion (4.2% Jan2037) for €3-4B. These bonds also cheapened in the run-up to the auction. The Jan2019 & Jan2037 SPGB's look good on the Spanish curve while the Jul2030 Obligacion is expensive. We expect a plain vanilla auction.

 

ovish ECB vs neutral/hawkish BoE?

Overnight, most Asian stock markets lose ground with Japan underperforming on the back of a stronger yen. The US Note future ekes out some additional gains following yesterday's rebound on an unchanged Fed decision (see above). We expect the Bund to open higher as well.

Today's EMU/US eco calendar is uninspiring with only EMU PPI data and US weekly jobless claims. Central bank speeches (ECB Draghi, Praet, Coeuré) are wildcards for trading. We expect them to downplay the surge in headline inflation (1.8% Y/Y) because of subdued underlying price pressure (0.9% Y/Y). The BoE's policy decision could also impact Bunds and US Treasuries via the UK Gilt markets as the BoE probably hit the end of its monetary easing cycle (see FX). The new inflation report might point to higher future inflation, suggesting that the BoE will eventually need to follow in the Fed's footsteps more rapidly than expected. So in balance: core bonds could be caught between dovish ECB talk and neutral/hawkish BoE talk. In that case, and with recent German critic on the ECB’s policy in mind, we think that markets will be more sensitive to the BoE’s message.

From a technical point of view, the Bund's break below the neckline of a double top (162.62) is negative. We expect the Bund to go for a test of the bottom/cycle low. The US Note future trades in the 122-14+ - 125-09 sideways range. We expect also a move towards the lower bound of the range. We hold our negative views on both German Bund and US Note future on the back of accelerating growth and inflation. US investors still have to adapt to the Fed's 2017 rate hike scenario (3 hikes) while European investors might face another "recalibration" of the ECB's APP-programme in H2 2017.

Download The Full Sunrise Market Commentary