Core bonds gain some ground ahead of today's data

Core bonds gain some ground ahead of today's data

Core bond markets eked out some gains in another consolidating session . The US Note future temporarily lost ground on strong PPI and low claims data, but the move didn't last long. That may change today if the triplet of CPI, retail sales and consumer confidence surprise on the upside (see below). A strong 30-yr bond auction and fresh geopolitical concerns about Iran helped sustain yesterday's bid. US president Trump will decide today whether to prolong the Iran deal or step out of the multinational agreement.

In a daily perspective, US yields declined by 0.6 bps to 3.6 bps, flattening the curve. German yields declined by 1 bp (30-yr) to 2.5 bps (5-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany were mixed with Italian BTP's outperforming (-3 bps) following a good auction and as the lower house approved via 3 confidence votes changes to the electoral law. It now goes to the Senate. Spanish spreads widened 2 bps, after Wednesday sharp narrowing and waiting on the Catalan response to PM Rajoy's question (threat).

US eco calendar heats up

The triplet of US inflation, retail sales and Michigan consumer confidence is potentially market-moving. Consumer inflation likely increased sharply, especially due to higher gasoline prices (a hurricane effect). We are especially looking to the core inflation, which in August showed signs of bottoming out after months of a steady decline in the inflation rate (Y/Y). Yesterday's core PPI showed an upward surprise, while headline PPI was strongly influenced by higher energy prices. While headline CPI estimates are already high at 0.6% M/M and 2.3% Y/Y, the core might surprise on the upside (expected 1.8% Y/Y up from 1.7% Y/Y previously). Retail sales are expected very strong (1.7% M/M). Unit car sales rebounded and sales at gasoline station should have done well (price effect). However, also core sales should have rebounded. Given the high expectations, we side with the consensus. We see no reasons why consumer sentiment should have declined from cycle highs. The combination of these results, if confirmed, would further galvanise expectations that the Fed will increase rates in December and maybe stimulate markets to discount more rate hikes in 2018 than hitherto. Fed governors Evans, Kaplan & Rosengren and ECB Mersch & Constancio speak.

Geopolitics vs US eco data

Most Asian stock markets trade positive overnight, outperforming WS. The US Note future trades stable, suggesting a neutral opening for the Bund.

Today's eco calendar heats up in the US. We expect strong eco data with upside risks to core inflation. Such outcome is negative for US Treasuries. In yield terms, we could see a new test of the resistance level at the 5-yr (1.97%), but we don't anticipate a break higher. Tests in the US 10-yr yield (2.4%) and 30-yr yield (2.95%) are unlikely as this week's correction went further at the longer end of the curves. Any downward reaction in core bonds will probably be short-lived with geopolitical uncertainty high on the agenda. Ahead of the weekend, safety flows might dominate. Catalan President Puigdemont is running out of time to answer to Madrid, Austrian elections will probably lead to a right government and US President Trump threatens to blow up the nuclear pact with Iran. Central bank speakers are wildcards for trading. With the key October 26 ECB meeting rapidly approaching, any comments on APP could become market sensitive. We expect an extension from December 2017 to June 2018, while lowering the monthly amount of purchases from €60 bn to €30 bn starting in January. Recent rumours suggests halving the pace of purchases, but a 9-month extension instead of 6 months.

Technically, US yields ran into resistance after Friday's payrolls, initiating some short term consolidation. A December rate hike is now almost completely discounted. Adding the geopolitical context and US/German stock markets at record levels (ready for some profit taking?) even suggest a small positive bias for core bonds in. We hold a sell-on-upticks strategy both in the US Note future (entry around 126) and the Bund (entry levels around 162).

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