Bund and US Note future sold off with US Treasuries underperforming

KBC Market Research Desk KBC Bank

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Bear steepening in opening session of the NY

Global core bonds started the New Year on a weak footing. Both the Bund and US Note future sold off with US Treasuries underperforming, partly catching up with Bund weakness in the illiquid final trading days of last year. Higher oil prices (see graph) and hawkish comments by ECB Coeuré & Nowotny might have been at play. The ECB members warned that APP won’t be extended beyond September and Nowotny added bubble risks on European stock markets. A strong US equity market opening inflicted additional losses on mainly the US Note future. The eco calendar was empty apart from Markit’s confirmation the final EMU manufacturing PMI at a very high 60.6.

In a daily perspective, both the US and German yield curves bear steepened. US yields increased by 3.6 bps (2-yr) to 7.4 bps (30-yr) while German yields added 1.7 bps (2-yr) to 5.1 bps (30-yr). 10-yr yield spreads versus Germany ended narrowly mixed with Portugal (+3 bps) and Italy (+5 bps) underperforming. Italian president Mattarella dissolved parliament last week, preparing for early parliamentary election (March 4) which could result in a political deadlock. Therefore, more underperformance is possible. Irish spreads remained steady despite the Treasury’s announcement of a near term €3-4bn syndicated bond sale (May2028; likely today).

Asian stock markets trade positive overnight in line with the US yesterday. The US Note future and Brent crude trade stable, suggesting a neutral opening for the Bund. Trading will be mainly guided by the US eco calendar today with US manufacturing ISM and FOMC Minutes. The ISM is expected to have remained strong in December, in line with other global PMI/ISM’s already published. A stabilization at 58.2 is forecast. The market reaction to activity data was muted of late. FOMC Minutes might show more insight in the Fed’s determination to hike rates three times this year. A potential risk to this scenario is increased cautiousness by Fed members to mysteriously low inflation. That might cause an uptick in US Treasuries, but we don’t expect such move to last and eye a test of the 123-12+ low in the US Note future. We think that the Fed will hike rates in March. The market implied probability of that scenario is 70%.

German Bund sentiment deteriorated sharply since the end of last month. Strong present and expected growth warrants such move. We think that the ECB will have to change its guidance on APP and interest rates in 2018, acknowledging these developments. We hold our short positions and target the September low (159.78).

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KBC Market Research Desk

KBC Bank

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