Disconnect between Bund and US Note future

KBC Market Research Desk KBC Bank

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Disconnect between Bund and US Note future

German Bunds (higher) significantly outperformed US Treasuries (lower) yesterday. Fed chairwoman Yellen reiterated over the weekend confidence that inflation will move to target next year, warranting more gradual rate hikes. Her message slightly weighted on US Treasuries as did the only eco item on yesterday’s agenda. The US empire manufacturing for October beat consensus, matching the highest level since 2009. Some European election-related uncertainty might have been at play as well with the (expected) Austrian shift to the right, the (unexpected) outcome of German regional election (Lower Saxony) and the lasting political deadlock between Spain and Catalunya.

At the end of the session, the German yield curve bull flattened with yields 1.2 bps (2-yr) to 3.6 bps (30-yr) lower. The US yield curve ended 1.8 bps (30-yr) to 5 bps (5-yr) higher. On intra-EMU bond markets, 10-yr yield spread changes versus Germany ended unchanged with Portugal underperforming (-3 bps) and Greece & Italy outperforming (-2 bps).

German ZEW and US IP on the agenda

Today’s eco calendar contains German ZEW investor sentiment and US industrial production data. Both the current situation and expectations indices of German ZEW are expected to increase in October, respectively from 87.9 to 88.5 and from 17 to 20. We side with consensus for the current assessment even as the indicator is near all-time highs because the German Dax reached multiple record highs during the reporting period and because all economic indicators point in the right direction. A difficult government coalition ahead might weigh on the forward looking and market-relevant expectations index. US industrial production is expected to rise by 0.3% M/M in September, following a 0.9% M/M decline in August. Risks might be on the downside as manufacturing could still be distorted by the impact from Hurricanes Harvey and Irma. ECB Constancio and ECB Praet are scheduled to speak, but both talked recently, so their comments probably won’t have any market impact unless they elaborate of the future of APP. Philly Fed Harker normally won’t touch on monetary policy.

More outperformance German Bund?

Most Asian stock markets eke out gains in line with the US yesterday. The US Note future loses marginally ground while Brent crude stabilizes. We expect a neutral opening for the Bund though.

Today’s eco calendar contains German ZEW investor sentiment and US industrial production. Risks are on the downside of expectations (positive core bonds), but they aren’t the most important eco figures for trading. The German Finanzagentur holds a Schatz auction (€4bn 0% 2019) today. Total bids averaged €5.95B at the previous 4 Schatz auctions. We expect plain vanilla demand. Central bank speakers are a wildcard, especially at the ECB side with the rapidly approaching October 26 ECB-meeting in mind. 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. Markets reacted in dovish way to these rumours as they suggest that a first rate hike is still far away. The Bund’s outperformance vs the US Note future is expected to last.

Technically, the German Bund broke above the 162 mark, implying a full retracement towards the contract high. European election outcomes (Germany, Austria, Catalonia) and ECB rumours caused outperformance vs the US Note future. We hold a sell-on-upticks strategy both in the US Note future (entry around 126), but put it on hold for the Bund.

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KBC Market Research Desk

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