Core bonds recover in absence of inflation uptick

Core bonds eked out modest gains yesterday with UK Gilts again outperforming German Bunds and US Treasuries. Bets on a January rate cut rose north of 50% following a disappointing UK CPI inflation print. EMU bonds put on a decent performance given huge EMU bond supply. Belgium and Italy launched new syndicated deals, raising €6bn (Jun2030) and €7bn (Sep2050) respectively while Germany tapped the very long end. Europe's primary bond market already crossed the €150bn mark since the start of the year. That's nearly a week earlier than last year. The ECB's Q4 2019 revamp of asset purchases is the main driver behind successful supply operations. Eco data, US and China signing their Phase 1 trade deal, central bank speeches, and the Fed's Beige Book left no traces on markets. We retain that voting Dallas Fed governor Kaplan repeated this week's earlier warning by Boston Fed Rosengren that growth in the Fed balance sheet is supportive of higher valuations and risk assets (possible financial stability risks). The German and US yield curves both bull flattened. German yields lost 0.8 bps (2-yr) to 3.6 bps (30-yr) while US yields declined by 1.7 bps (2-yr) to 3.4 bps (30-yr). 10-yr yield spread changes vs Germany were unchanged with Italy (+3 bps) underperforming.

Most Asian stock markets cede some ground this morning with South Korea outperforming. Core bonds tread water. Today's eco calendar contains US retail sales, Philly Fed Business Outlook and weekly jobless claims. We see upside risks for retail sales but can they impress markets? We think investors are looking more at potential clues of inflation picking up rather than to the domestic data. Core bonds regained some vigor since wage inflation (last Friday), US CPI inflation (Tuesday) and PPI numbers (yesterday) didn't deliver the feared overshoot. We think that can remain the case this week with positive trade vibes also fading. Minutes of the ECB meeting, a Lagarde speech (unlikely to touch on monetary policy) and Q4 earnings serve as today's wildcards.

Technically: core bond yield's Q4 upleg was interrupted at the start of the year because of the US-Iran conflict. Geopolitical tensions in the Middle East again proved to have a limited shelf date as market theme. Inflation risk premia remain underpriced at current yield levels and could grab market attention with eg inflation expectations bottoming out. The German 10-yr yield tested -0.18% (July high)/-0.15% (38% retracement of Feb '18 – Sep '19 decline) resistance, but a break didn't occur (yet). The US 10-yr yield on multiple occasions failed to take out the 1.94% upper bound of the reigning trading channel.

Download The Full Sunrise Market Commentary