Bund outperforms with important technical break

KBC Market Research Desk KBC Bank

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Core bonds traded mixed yesterday with Bunds outperforming US Treasuries. The technical break of the German 10-yr yield below 0.62% contributed to the Bund's outperformance amid an empty European eco calendar. Second tier US eco data played no role. The US 10-yr yield ran into first intermediate support around 2.8%. US politics continue to play first fiddle, filling the eco/event void between now and next week's FOMC meeting. At this moment, it generates more safe haven flows into German Bunds instead of US Treasuries.

At the end of the day, the German yield curve bull flattened with yields 0.4 bps (2-yr) to 2.1 bps (30-yr) lower. The US yield curve bear flattened with yields 2.7 bps (2-yr) to 0.1 bp (30-yr) higher. 10-yr yield spread changes versus Germany ended nearly unchanged with Greece underperforming (+7 bps). Fitch (BBB; stable outlook) and Moody's (Baa2; negative outlook) decide on the Italian credit rating tonight. We expect no changes. S&P updates the Portuguese BBB- (stable outlook) rating.

The US Note future trades rather stable overnight and we expect a neutral opening for the Bund. Today's eco calendar contains several second tier US eco data which probably won't impact trading. As mentioned before, we don't think that investors are willing to set up new short positions ahead of next week's Fed meeting given Trump's high velocity of controversial political decisions. Investors could therefore prefer a cautious approach going into the weekend. Bunds benefit more than US Treasuries since last week's ECB meeting, which scaled back early European normalisation bets. The technical break in the Bund/German 10-yr yield also suggests further outperformance vs the US Note future. Our medium-term strategy remains unchanged though (higher US & European rates). We expect the Fed to hike rates next week with changes to the dot plot. More specifically, we expect a higher estimation of the neutral rate (3% from 2.75%) and a potential shift already in 2018 (4 from 3).

Technically, the trading band for the US 10-yr yield is 2.64%-3.05%. Short term, we expect a test of 2.8% intermediate support. The German 10-yr yield lost 0.62% support. The break suggests a return to 0.46%/0.48% support (gap open/62% retracement) unless we get a sudden shift in sentiment.

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KBC Market Research Desk

KBC Bank

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