Central bank talk important, but not today?

Rates

Bund lower for 5th consecutive session.

On Friday, the US cash bond market remained closed for Veteran's holiday, like various European markets. Despite these closures, the Bund traded nervous and volatile. An initial down-leg set a new sell-off low at 159.77, but losses were recouped by noon. However, the slide resumed in the afternoon, in thinner volumes, leading to a close at 160.27, a 37 ticks daily loss. In a daily perspective, German yields were up 1.5 bps at the 2-yr tenor and 3.4 bps at the 5-, 10- and 30-yr tenors. The 10-yr yield set a new sell-off high at 0.345 bps, but the 0.30/0.33% key yield resistance wasn't broken in the close. The 30-yr Bund yield approached the 1% threshold. The US Note future traded in very thin dealings and closed at 127-05+, down from 127-18 on Thursday, a new contract low. Michigan consumer sentiment unexpectedly rose to 91.6 in November from 87.2 in October, but the survey pre-dated the election. Inflation measures rose too, to 2.7% from 2.4% for the 1-yr and 5-to-10-yr expectation, the highest since mid-2014 (LT measure). Fed Fischer said the case for tightening is quite strong as the Fed is near achieving its objectives. In the intra-EMU markets, 10-yr yield spreads versus Germany widened substantially: 2-to-4 bps at the semi-core and 9/10 bps for Italy/Ireland.

Central bank talk important, but not today?

Dallas Fed Kaplan and Richmond Fed Lacker speak. Kaplan recently said the case for a hike is strengthening, but the Fed can be patient beyond its next step. Fed Lacker is a hawk, who favours tighter policy and said the case for raising rates is relatively strong. We don't expect them to drive markets, but stay attentive to eventual comments on Trump's policy and the reaction on that of the monetary policymakers. ECB Draghi probably won't speak about policy, but ECB vice chair Constancio may. He is a dove, but recently said that inflation may reach 1.3% Y/Y in spring, which suggests that a debate on policy inside the ECB is ongoing. EMU industrial production is expected at -1% Y/Y in September.
National data suggest a weak figure. However it is too outdated to affect trading in a lasting way.

Spain and France tap market on Thursday

This week's EMU bond supply is low with only Spain and France tapping the market on Thursday. The Spanish debt agency sells the on the run 3-yr Bono (0.25% Jan2019), 5-yr Bono (0.75% Jul2021) and 10-yr Obligacion (1.3% Oct2026). The amount on offer still needs to be announced. The French treasury taps the off the run OAT (3.75% Apr2021) and creates a new 5-yr OAT (0% May2022) for a combined €4.5-5.5B. This week's auctions will be supported by a €12.4B Italian redemption.

Unfriendly bond environment

Overnight, Asian stock markets lose some ground with China (stable) and Japan (+1.5%; weaker yen) outperforming. Last week's dominant trading themes (stronger dollar, higher rates) are still at play this morning, suggesting a weaker opening for the Bund.

Today's eco calendar is empty apart from central bank speeches (ECB Draghi, ECB Constancio, Fed Kaplan, Fed Lacker). Dallas Fed Kaplan is a moderate president who votes on policy next year. His comments could be most interesting from a market point of view. We expect the two ECB top guns to hold the policy line without frontrunning on the key December meeting. Sentiment will therefore be today's key trading theme and that remains bond unfriendly. Since Trump's election victory, the 5y5y market based measure for US inflation expectations increased from 2.21% to 2.47%. Markets expect a reflationary policy which will boost growth and inflation. If inflation expectations rise too rapidly, they could force the Fed to accelerate the timing of its very gradual tightening cycle. We hold our negative view versus core bonds and suggest a sell-on-upticks approach.
Peripheral bonds underperform Bunds.

Medium term technical pictures deteriorated. Better eco data, rising inflation expectations and central banks' change of tone (extraordinary policy won't last forever) triggered the sell-off which started at the beginning of October. The US 10-yr and 30-yr yields broke above 2% and 2.75% resistance. Next targets are 2.25% and 3.25%. The German 10-yr yield tested the upper bound of the trading range (0.10%-0.30%). A break opens the path to 0.50%.

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