End of APP overruled by lower for longer on rates

KBC Market Research Desk KBC Bank

Rates

Global core bonds gained ground yesterday with German Bunds significantly outperforming US Treasuries after the ECB meeting. The central bank decided to taper asset purchases in Q4 2018 to €15bn/month before ending them by the end of the year. As markets had come to view the early announcement of the ECB's intentions in regard to the ending of its APP as a possible pointer to an earlier and faster move on interest rates, yesterday's more explicit guidance on the timing of future rate moves came as something of a shock. The forward guidance on interest rates changed to ‘we (the ECB) expect them to remain at their present levels at least through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remains aligned with our current expectations of a sustained adjustment path'.

The dovish surprise on rates caused market to push back ECB rate hike expectations. The 3m forward Euribor curve now only turns positive in March 2020! German yields declined by 0.6 bps (30-yr) to 6.7 bps (5-yr) on a daily basis. The US yield curve bull flattened with yields 0.4 bps (2-yr) to 3.2 (30-yr) bps lower. Strong US retail sales softened the blow. 10-yr yield spread changes vs Germany narrowed up to 2 bps with Portugal (+2 bps) and Greece (+7 bps) underperforming.

Most Asian stock markets eke out small gains overnight with China underperforming as US President Trump is said to approve tariffs on $50bn of Chinese goods. The US Note future is marginally higher, but we expect a neutral opening for the Bund.

Dissecting yesterday's ECB message will feature high on today's agenda. We've found some hawkish elements (see extended review) which went unnoticed. Will today's ECB members (Nowotny, Coeure, Smets) try to balance the message? We don't fight against the tide and let the repositioning move do its work even if we wonder whether it has that much to go. US eco data include the empire manufacturing survey, industrial production and Michigan consumer confidence. Q2 US eco data, both soft and hard, printed very strong up until now and we have no reason to put that into question for today's outcomes. They could cause underperformance of the US Note future, but with this week's Fed and ECB meetings in mind, the downside is probably limited today.

Technically, the German 10-yr yield and US 10-yr yield respectively failed to break above 0.5% and 3% this week. We expect sideways consolidation going forward.

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KBC Market Research Desk

KBC Bank

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