Core bonds crash, as investors run for the exit

Rates

Yesterday, core bonds remained under downward pressure. It was initially limited to one move lower in the European morning session followed by sideways trading. In the afternoon, a renewed surge in oil and the entrance of US traders triggered more core bond selling. The stronger ISM was largely ignored, but a third selling wave occurred later in the session. It might have been triggered by rumours that the ECB was considering a formal signal after its December meeting that the bond buying programme will eventually end (after an extension). The US 10-yr yield approached 2.5% resistance (2.49%) and the US 5-yr yield finally took out 1.85% resistance (1.90%). The US 30-yr yield now trades near 3.10%. Fed rate hikes are now discounted for September 2017 and March and September 2018. In a daily perspective, the US curve bear steepened with yields up between 3.4 bps (2-yr) and 7.4 bps (30-yr). The German curve steepened too with the 2-yr yield down 0.5 bps and the 30-yr year up 10.2 bps with new closing highs for the 10-yr (0.37%) and the 30-yr Bund yields (1.04%). In the intra-EMU bond market, 10-yr yield spreads narrowed 3-4 bps, including for Italy which faces a referendum on Sunday.

US payrolls, eye-catcher of the day

The November US payrolls won’t be important for the outcome of the December 14 FOMC meeting. A 25 bps rate hike is baked in the cake. The report is important though for market perceptions about the pace of monetary tightening next year. In the context of the incoming administrations’ fiscal plans and given already tight labour markets, it should normally lead to more tightening. The Fed projections’ contain 2 rate hikes in 2017, while markets discount only one. Markets expect a 180K increase payroll increase with a stable unemployment rate (4.9%) and a 0.2% M/M /2.8% Y/Y increase in Average Hourly Earnings (AHE; 0.4% M/M/ 2.8% previously). The headline 180K increase would follow an increase by 161K in October. We see risks to the upside (200K?) based on a negative weather effects on the East coast (hurricane Mathew) that artificially lowered the October outcome. Such effect was visible in the state payroll data that have been released since. Other recent November eco data like consumer confidence, but also weekly retail sales, point in a similar direction. Besides the headline number, any upside surprise in the AHE (wage growth) wouldn’t go unnoticed. With markets itchy, surprises should move them.

Correction time, even in case of stronger payrolls?

Overnight, Asian stock markets lose up to 1%. The US Note future gains some ticks while Brent crude loses modestly ground. We expect a slightly higher opening for the Bund.

Today it’s all about the payrolls. Risks are on the upside of expectations which is negative for core bonds. The US 5-yr (1.85% area) broke and 10-yr yield (2.5%) reached key resistance levels. Stronger payrolls will trigger an intense test, but yesterday’s post-ISM reaction suggests that a break will be difficult following the huge November bond sell-off. The equity and dollar rally also show signs of petering out while oil prices might also give back some of the post-OPEC gains. Ahead of the weekend, some short covering could occur after the payrolls, going into the Austrian presidential elections (toss-up between far left and far right candidate) and Italian referendum (probable defeat for PM Renzi). Both events could put peripheral bond markets under some pressure today, even if the “damage” remained limited so far.

Any correction higher in core bonds markets could be used to sell-the-uptick short term. We hold our medium term negative view on the US Note future and Bund.

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