Dull session ends with solid bond rally

Rates

Yesterday, global core bond started the week on a dull footing, but a solid rally in the second half of US trading led to moderate/substantial gains. EMU consumer confidence was strong, but a tad below consensus. The Bund tested 162.47 for the second day in a row, but bounced off this key support. The rebound higher accelerated when US Treasuries started to rally. It might have had a technical reason (massive shorts Treasury base in futures), but also comments of president Trump probably played a role. He repeated that he would cut taxes and regulation massively, without giving specifics. He also threatened again with a border tax for leaving firms and later officially pulled support for the Trans Pacific Partnership trade agreement. US Treasury gains were preserved despite equities gradually recouping half of the losses. In a daily perspective, the German yield curve bull flattened with yields 1.4 bps (2-yr) to 7 bps (30-yr) lower. Changes on the US yield curve varied between -4.5 bps (2-yr) and -7.3 bps (5-yr), the belly of the curve outperforming. On intra-EMU bond markets, 10-yr yield spread changes versus Germany widened up to 3 bps (Italy) as a Court decision on the election law looms (today), BTP’s will be issued and the Eurogroup will discuss the BMPS bailout (Thursday).

Eurozone PMI business confidence key release

January EMU PMI’s are expected broadly stable at 54.8 for the manufacturing and 53.8 from the services sector. The manufacturing PMI is up for four consecutive months (more than 3 points) which is remarkable. The services PMI strengthened in October and November, before flattening in December (53.7). At face value, one would deduct from the data that the international cycle accelerates, while the more domestically oriented sectors keeps a steady, albeit solid, pace of activity. Given past gains, we expect a strong report, but not necessarily stronger than in December. The US eco calendar contains the Markit US manufacturing PMI, no market mover, the Richmond Fed survey (decline from 8 to 6 expected) and existing home sales (decline from 5.61M to 5.5M expected). The risks for the Richmond Fed are on the upside given strong results in the NY and Philly Fed surveys. Higher mortgage rates, higher prices and tight inventories point weakening existing home sales (from strong levels). The UK and Italian Constitutional Court’s verdict on Brexit (see FX) and on the Italian electoral law are interesting. The former may delay triggering article 50, as the Northern Irish parliament is dissolved. The latter may give the impression of still more political instability in Italy and may lead to early elections.

The Netherlands, Spain, France and US tap market

The Dutch debt agency taps the on the run 5-yr DSL (€2-3B 0% Jan2022). The bond traded stable in ASW spread terms going into the auction, but is relatively cheap on the Dutch curve. We expect decent demand. The Spanish Treasury announced the near term syndicated sale of a new 10-yr Obligacion (Apr2027). The French debt agency intends to sell a long 20-yr Green Bond (Jun2039). The new bond will finance expenditure identified as promoting energy and ecological transition. In the US, the Treasury starts its end-of-month refinancing operation tomorrow with a $26B 2-yr Note auction. Currently, the WI trades around 1.18%.

Core bond rebound set to slow?

Overnight, most Asian stock markets trade positive with Japan underperforming. The US Note future and Brent crude trade stable, suggesting a neutral opening for the Bund.

Today’s main item on the agenda are EMU PMI’s. We expect strong, but near consensus, readings. In combination with heavy bond supply, this could slow any rebound of the Bund, which bounced off key support (162.62-47) yesterday. During US dealings, risk sentiment was the key driver over the past two sessions. Trump’s rhetoric set the stage for risk aversion, lifting US Treasuries. With the scheduled US end-of-month refinancing operation and 125-09 resistance approaching, we expect the rally to slowdown as well.

Longer term, we hold our negative views on both German Bund and US Note future on the back of accelerating growth and inflation. US investors still have to adapt to the Fed’s 2017 rate hike scenario (3 hikes) while European investors might face another “recalibration” of the ECB’s APP-programme in H2 2017.

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