German bonds slightly underperform US Treasuries

Rates

US Treasuries eked out some gains in the Asian session, as risk-aversion linked to North-Korean nuclear test threats, dominated trading. They kept the gains, but moved sideways further out. The Bund opened higher, reflecting US Treasury gains, but soon slid lower as risk sentiment improved and EMU PMI business confidence largely exceeded expectations. It confirms the buoyancy of the euro area economy. The Bund bottomed even before noon and struggled higher to erase all losses, maybe partially helped by declining equities. All in all, the bond moves were minor, but more than half of the post FOMC losses on Wednesday have now been recouped. Central bankers (Williams, Constancio, see Friday’s KBC Sunset) gave a number of interesting comments that were however largely ignored.

In a daily perspective, US yields declined between 0.7 bps (2-yr) and 2.7 bps (10-yr), while German yields are little changed (between flat and -0.7 bps). On intra-EMU bond markets, 10-yr yield spreads versus Germany are unchanged.

 

IFO business confidence and Central Bank speakers

German IFO business Climate is expected virtually unchanged in September at the highest level since the start of the series in 1991. Needless to say that the German economy is thriving. We have no signals that the German economy is over its peak. The Markit PMI’s improved quite strongly in September, but they were a bit weaker in June/July, contrary to the IFO. German equities have done well in September, but the stronger euro is a potential negative, even if firms didn’t complain yet. Therefore, we dare not put the risks on the upside of expectations. The Dallas Fed business confidence indicator is likely distorted by the tropical storms.

The event calendar is busy. ECB Constancio, Mersch, Draghi and Coeuré take stage. Constancio gives a welcome address at an ECB research conference and Mersch speaks on risk management. Whether Draghi will give markets some guidance on future policy is unclear as well. Coeuré chairs a panel on the exit from non-standard monetary policy, a theme markets currently focus on. This might bring interesting insights. From the Fed side, NY Fed Dudley and Chicago Fed Evans are speakers on duty. The title of Dudley’s speech suggests that monetary policy will not be the topic. We strongly suspect Dudley was amongst the eleven governors who expect still a rate hike in 2017. Evans is a dove and he probably was one of the four governors who doesn’t expect a rate hike anymore in 2017. He is concerned about the low inflation.

 

Germany, Italy and the US supply market

This week’s scheduled EMU bond supply is low with only Germany and Italy on the agenda. The German Finanzagentur holds a €4B 2-yr Schatz auction tomorrow (0% Sep2019). Italy holds zero-coupon and inflation-linked bond auctions tomorrow and its regular BTP-auction on Thursday. Lines and amounts on offer still need to be announced, but normally it will be 5-yr and 10-yr BTP taps, eventually supplemented with off the run LT BTP’s. The US starts its end-of-month refinancing operation tomorrow with a $26B 2-yr Note auction. They continue on Wednesday with $13B 2-yr FRN and $34B 5-yr Note auctions. On Thursday, the Treasury concludes with a $28B 7-yr Note auction.

 

Short term Bund gains after German elections?

Risk aversion reigns overnight with Asian stock markets up to 1% lower. EUR/USD loses some points. The US Note future gains a few ticks and we expect a stronger opening for the Bund as well. German elections ended with a Pyrrhic victory for Merkel’s CDU/CSU and creates some uncertainty. The SPD’s voluntary move to the opposition paves the way for a coalition with Liberals and Greens, but is less “European friendly”. Peripheral spread widening could be the result today.

Today’s eco calendar contains German Ifo. We expect a near consensus outcome, suggesting that it won’t be the main impetus for trading. A plea of central bank speakers are wildcards (see above), but most won’t touch on monetary policy. The front end of the US yield curve can nevertheless underperform if Fed governors stress their willingness to hike rates in December (especially dove Evans). ECB heavyweight Coeuré can touch on the future of APP. Risk sentiment and German elections will dominate trading, suggesting more room to take some profit on short positions in the German Bund. US supply is negative for Treasuries this week.

After the FOMC meeting, we concluded that US Treasuries re-entered a sell-on-upticks phase after the Fed confirmed its view on 2017/2018 interest rate policy. A December rate hike isn’t fully discounted yet. Short term though, we expect some correction higher. We hold a sell-on-upticks view in the Bund as well as the ECB’s normalisation process slowly takes off. From a technical point of view, both the Bund and the US Note future fell below uptrend lines (early September) since the start of summer, making the picture neutral from bullish.

 

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