Core bonds can’t really profit from risk aversion

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Core bonds can’t really profit from risk aversion

US Treasuries surprisingly outperformed German Bunds yesterday. Both performed well during European dealings on the back of equity weakness (PBOC governor Zhou warned of Minsky moment) and Spanish developments (Madrid initiated article 155). The Bund soon returned towards opening levels and any Spanish asset underperformance was rapidly undone as well, in line with previous days. Investors clearly think that the Spanish-Catalan stand-off won’t spiral out of control. US eco data printed very strong with historically low jobless claims and a strong Philly Fed Business outlook, but it was only when US stock markets started reversing opening losses that US Treasuries also started sliding back. Minutes before the closing bell, Treasuries spiked again higher on headlines that Politico reported that Trump was leaning toward Powell for Fed chair.

At the end of the day, US yields declined by 4 bps (5-yr) to 1.9 bps (30-yr). Changes on the German yield curve were limited between -0.1 bp (30-yr) and -0.9 bps (2-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany closed nearly unchanged with Portugal outperforming (-4 bps) and Greece underperforming (+5 bps).

Eco calendar won’t play a role of importance

Today’s eco calendar is unattractive with only US existing home sales. US housing data recently showed signs of peaking. Consensus expects a 0.9% M/M decline in September. This data series won’t impact trading though. Cleveland Fed Mester speaks on global regulatory structure. After US close, Fed chairwoman Yellen talks on monetary policy since the financial crisis. It’s probably one of the last speeches before the black period kicks in. Yellen has on several occasions suggested that the US central bank should continue its gradual rate hikes. A December rate hike is largely discounted, so markets will only react if she changes her mind which we deem unlikely.

US reflationary spirits in the driving seat?

Asian stock markets trade positive with Japan underperforming (flat). US Treasuries lost significant ground while the dollar profited after the US Senate adopted a budget for the next fiscal year, clearing a crucial hurdle for tax reforms. We expect some spill over effects in the Bund in the opening.

Eco data and central bankers won’t impact trading today. The Catalan-Madrid stand-off escalated to a new phase, but investors remain very calm. It’s hard to tell which card investors will play today. The US Senate’s budget approval could spark the reflation trade, weighing on core bonds with an underperformance of US Treasuries. European investors might decide to take a wait-and-see attitude though with next week’s ECB meeting looming on the horizon. Risk sentiment on stock markets is a wildcard for trading with main indices showing some signs of vulnerability. Profit taking on stock markets ahead of the weekend could in this scenario underpin core bonds.

Technically, the German Bund broke above the 162 mark, implying a full retracement towards the contract high. European election outcomes (Germany, Austria, Catalonia) and ECB rumours caused outperformance vs the US Note future. We hold a sell-on-upticks strategy in the US Note future (entry around 126), but put it on hold for the Bund ahead of the ECB meeting.

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