European reflation trade if Brexit hurdle is removed?
Global core bonds walked a different path yesterday with German Bunds underperforming US Treasuries. Diverging headlines on Brexit sparked intraday volatility, but the bottom line remains that the EU and the UK are on the brink of a draft Brexit deal with the last hurdle remaining... Northern Ireland's status. Even if both parties reach an agreement at tonight's EU Summit, the litmus test will only come on Saturday with a potential key vote in UK Parliament. Convincing the Northern Irish DUP party seems to be the toughest nut to crack. Whatever, the prospect of seeing two years of uncertainty removed, weighed on the Bund. It could unlock delayed investments and rejuvenate European growth. The German yield curve bear steepened with this reflationary thought in mind. German yields added 1.3 bps (2-yr) to 3.8 bps (30- yr). The German 10-yr yield followed the 5-yr's example earlier this week, by surging above 1st important resistance (-0.41%). 10-yr yield spread changes vs Germany narrowed slightly with Greece and Italy outperforming (-5 bps).
US Treasuries eked out gains after disappointing US retail sales. The Fed's Beige book later showed that the US economy has only grown at a "slight to modest pace" with deterioration especially in manufacturing and agriculture. Voting Chicago Fed Evans later said that the Fed may want to cut rates again given all the uncertainties out there. US yields fell by 3.6 bps (5-yr) to 1 bp (30-yr) on a daily basis.
Asian stock markets trade mixed this morning. The German Bund and US Note future give no clear direction neither, suggesting a neutral start to European trading. General risk sentiment will again set the tone for trading. Expect your daily dose of volatile Brexit headlines ahead of tonight's EU Summit. The door for an accord will probably remain open, holding Bunds lower. The US eco calendar contains building permits, housing starts, weekly jobless claims and Philly Fed Business Outlook. (US) markets continue to react in an asymmetric manner, mainly moving on disappointments. US Treasuries can continue outperform Bunds. Q3 earnings and central bank speeches are wildcards.
Technically, the German 10-yr yield and US 10-yr yield both rebounded away from August lows following ECB/Fed September policy meetings. Risk sentiment and eco data drove action within sideways ranges since. The German 10-yr yield broke above -0.41% as Brexit deal hopes surge. Target of this double bottom formation are -0.25% and -0.13%. The 38% retracement level of the steady decline between October and August stands at -0.24%.
Author
KBC Market Research Desk
KBC Bank
