Fed Powell strikes note of caution

Rates

Core bonds gained more modest ground yesterday with US Treasuries outperforming German Bunds. The US inflation readings were almost spot on forecasts and didn’t influence trading. Risk sentiment soured in the US after a positive opening and dragged US yields lower. US yield changes ranged between -2.7 bps (5-yr) and +0.7 bps (30-yr). German yields declined by 0.2 bps (2-yr) to 1.3 bps (10-yr). 10-yr yield spreads vs Germany widened by 5 to 6 bps (Greece/Italy). Italian BTP’s didn’t really suffer from the government’s decision to let the EU deadline pass without an altered 2019 budget proposal.

Asian stock markets eke out small gains overnight with China outperforming and Japan underperforming. Signals on US trade range between negative (USMCA) over mixed (EU) to positive (China). The US Note future treads water. Fed chair Powell remains very positive on the US economy, but added that a previous tailwind, global growth, is losing strength and needs close monitoring. It’s the first time that he issues such a warning. Another one of his concerns is the recent slowdown in the US housing market, while the US must also take into account that the fiscal stimulus boost won’t last forever. So overall, he stroke a note of caution for the future. We don’t expect them to interfere with a December rate hike, but the Fed’s new guidance for 2019 will be worth watching. More Fed speakers line up today with vice-president Quarles, Atlanta Fed Bostic and Minneapolis Fed Kashkari. Will they send similar warnings?

Today’s eco calendar heats up in the US with retail sales, weekly jobless claims, empire manufacturing survey and Philly Fed business outlook. We expect them to confirm Fed Powell’s bullish view on the current state of the economy. That could inflict some losses on core bonds especially if the improvement in risk sentiment lasts. We’ll scan speeches by ECB heavyweights de Guindos, Praet and Coeuré, looking for clues on the likelihood of a new set of TLTRO’s next year and on changes to the current playbook for reinvestments. Both probably feature high on the central bank’s December agenda and can potentially influence peripheral bond markets.

Technically, the US 10-yr yield sits in a narrow 3.06%-3.26% trading range. We continue to expect a break higher going into year-end because of the Fed’s tightening cycle. The German 10-yr yield trades in the middle of the 0.3%-0.6% sideways range with no immediate risks of a break-out in either direction.

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