Core bonds consolidate in fragile risk climate

Core bonds eked out some small additional gains yesterday. Risk aversion played a role during European trading with USD/JPY significantly losing ground and European stocks under pressure. The eco calendar only contained stronger-than-expected NFIB small business optimism. Risk sentiment on stock market improved during US trading, but caused no turnaround on the bond market. Changes on the German yield curve were limited between + 0.6 bps (2-yr) and -0.6 bps (10-yr) with an underperformance of the 30-yr yield (+2.4 bps). The US yield curve flattened with yield changes varying between +2.8 bps (2-yr) and -3.2 bps (30-yr). Voting Fed-member Mester, who is rumored to have a good shot at becoming next Fed vice-chair, said that recent market turmoil didn’t alter her mildly hawkish views on monetary policy. On intra-EMU bond markets, 10-yr yield spread changes versus Germany widened 1 bp with the periphery underperforming (+6 bps for Portugal, Spain and Italy; +11 bps for Greece).

The US Note future continues trading with an upward bias this morning as yen strength remains a theme. USD/JPY briefly fell below 107, to the lowest level since the end of 2016. Collateral damage on Asian bourses remains limited, putting the traditional market correlations once more to the test. We expect a somewhat stronger opening for the Bund.

Today’s eco calendar heats up in the US with the key CPI release and retail sales. Inflation is expected to slow to 1.9% Y/Y (from 2.1% Y/Y) for the headline index and to 1.7% Y/Y (from 1.8% Y/Y) for the core measure. Monthly readings are expected to print at 0.3% and 0.2% respectively. The current (modest) comeback of core bonds could gain some momentum in case of a below or at consensus outcome. We doubt that core bond sellers will come out in strength on a higher reading in the current fragile risk-off climate. US retail sales are forecast to show a 0.2% monthly advance, but activity data are at this moment less important than price data.

Short term, we favour more consolidation, but strong growth momentum, rising inflation (expectations) and the global turn towards monetary policy normalization are structurally negative factors for core bonds medium term. US and German yields cleared resistance levels earlier this year and moved towards next targets. The trading band for the US 10-yr yield is 2.64%-3.05%. Correction towards the lower bound could be used to put up short positions in the Note future. The German 10-yr yield’s trading band is 0.62%-1.06%.

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