Core bonds weather the 'storm'

Next KBC Reports will be published on Wednesday , the 3 rd of January 2018.

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Core bonds weather the “storm”

Global core bonds ended near opening levels yesterday. Given developments of the last 48 hours, the Bund and US Note future have shown quite resilient. First, the Fed as anticipated continued its tightening cycle on Wednesday night while also leaving the 2018 (3 hikes) and 2019 (2 hikes) scenarios in place. The December hike was discounted, but the 2018/2019 path isn’t. Second, EMU (December PMI survey) and US data (November retail sales; weekly jobless claims) printed very strong and confirm both economies’ momentum. Finally, the ECB kept policy unchanged, but significantly upgraded its growth outlook. Dovishness on inflation prevailed though.

In a daily perspective, the German yield curve flattened with yield changes ranging between +3.1 bps (2-yr) and -2.5 bps (30-yr). Changes on the US yield curve were quite similar, varying between +3.7 bps (2-yr) and -2.1 bps (30-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany narrowed up to 2 bps with Spain (-5 bps), Portugal (-6 bps) and Greece (-15 bps) outperforming.

Today’s EMU eco calendar is empty apart from speeches by ECB Nowotny and Rimcevics. Both gentlemen speak at national events, suggesting they’ll refrain from commenting on monetary policy. If they nevertheless do so, you could expect some hawkish counterweight to yesterday’s dovish Draghi comments. ECB monetary hawks remain a minority on the board though, limiting their market moving potential at this stage. The US eco calendar contains December empire manufacturing and November industrial production. The empire manufacturing index is expected to show a small decline from 19.4 to 18.7. Industrial production is forecast to normalize at 0.3% M/M following a post-storm rebound in October (0.9% M/M).

Trading expected to shift in lower gear

Most Asian stock markets lose ground overnight with China underperforming (-1%). The US Note future nevertheless trades with a small downward bias. Several dollar crosses also point in different directions, giving no strong indication for the start of dealings. The Bund could marginally profit from a weaker European equity opening.

Today’s eco calendar is thin with only US empire manufacturing and industrial production. We don’t expect them to influence trading. With the final key events of the year behind us, volumes will probably slow to a trickle. That could cause some erratic moves in coming days.

Technically, the US Note future trades in the 123-27/125-14+ sideways range. In yield terms, we eye a test of 2.47% into year-end. The Fed remains on path to hike rates three times next year and that’s not yet completely discounted. US tax reforms will probably get a green light before the end of the year, moving attention to an infrastructure plan early 2018. The German Bund set a new contract high earlier this week, but this wasn’t confirmed by a drop of the German 10-yr yield below 0.3%. We don’t anticipate such move and suggest putting short positions around current levels. Strong present and expected growth warrants such move. We think that the ECB will have to change its guidance on APP and interest rates in 2018, acknowledging these developments.

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