German IFO and US Fed Minutes eye-catchers today

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Bonds recoup losses despite strong equities & higher oil

Yesterday, global core bonds lost modest to moderate ground in the European and US morning session, as EMU business sentiment surged, suggesting that euro area growth is still accelerating. The initial decline went gradual and hand in hand with rising equities and higher oil prices. All in all, the decline remained modest, partly as uncertainties about the European election season, and especially the French presidential race, were omnipresent. The turnaround was triggered by a weak US Markit PMI, which is usually completely ignored and by another French poll showing that Le Pen's chances for winning the second round, while still a long shot, are improving. Core bonds erased initial PMI-initiated losses. At that time, the cash markets were closed. The French curve bear flattened with 2- and 5-yr yields 3 and 4 bps higher. The 2-yr yield spread between Germany and France even moved as high as 45 bps, suggesting that investors start to price in redenomination risk. A similar underperformance of the shorter (but here also longer) end was visible on the Italian curve.

In a daily perspective, the German yield curve was little changed and marginally steeper with yield changes varying between -1.5 bps (2-yr) and +1 bp (30-yr). US yields ended 1.4 to 1.8 bps higher. On intra-EMU bond markets, 10-yr yield spread changes versus Germany ranged from +3 bps for France to +6/7 bps for Italy and Spain (see higher). Greece (-33 bps) outperformed as the probability of a successful conclusion of the bail-out review and the ability to pay the maturing Greek bonds in July (about €6B) increases.

 

German IFO and US Fed Minutes eye-catchers today

The German IFO is expected marginally weaker in February at 109.6 (from 109.8) after a heavy drop in January. However, after very strong German PMI's yesterday, we put the risks on the upside of consensus. In the US, attention goes to the January FOMC Minutes. We don't expect the Minutes to be shocking, as they follow chairwoman Yellen's (rather hawkish) testimony before Congress last week. They probably won't give us new insight in the timing of the next rate hike. The January FOMC statement showed no hints of a nearby rate increase and the decision to keep rates unchanged was unanimous. However, the economic data have been very strong and inflation surprised on the upside recently. Yellen was more hawkish at her testimony when she said "it would be unwise to wait too long before tightening" and a number of governors like Harker, Kaplan, both voters explicitly pointed to the possibility of a March rate hike. We still think a June hike (even as May is a possibility) is more likely, because Trump's fiscal plans aren't known yet, but surprises aren't excluded. We are curious whether there are some hints about the balance sheet tapering.

 

German and US auctions

The German Finanzagentur taps the off the run 30-yr Bund (€1B 2.5% Jul2044). Total bids at the previous 4 30-yr Bund auctions averaged only €1.27B. The Bund traded rather stable in ASW spread terms going into the auction, but is the cheapest German bond at the very long end of the curve. We expect a plain vanilla auction.

The US Treasury started its end-of-month refinancing operation with a strong $26B 2-yr Note auction. The auction stopped through the 1:00 pm bid side with the strongest bid cover since August (2.82). Bidding details were very strong, especially the indirect and direct bids. Today, the US Treasury continues its operation with $13 2-yr FRN and $34B 5-yr Note auctions. Currently, the WI of the latter trades around 1.94%.

 

Underperformance US Treasuries vs Bunds?

Overnight, most Asian stock markets eke out small gains, but risk sentiment is less bullish than yesterday in US dealings. The US Note future nevertheless trades with a downward bias and Brent crude is a tad higher. We expect a softer opening for the Bund as well.

Today's eco calendar contains German IFO. Risks are tilted to the upside of expectations, which should keep the Bund away from nearby 164.90 resistance (0.29% support for German 10-yr yield). In US dealings, focus shifts to the FOMC Minutes. Last week's Yellen's testimony suggests that they won't reveal new info: the Fed doesn't want to wait too long to hike rates, but the impact of future fiscal policy remains uncertain. French election worries could continue to dampen (EMU) equity and bond sentiment (spread widening) and are a wildcard for trading, while the Eurogroup put the Greek issue to bed for some time.

US Treasuries start underperforming Bunds. Last week's Yellen testimony, hawkish Fed comments and strong US eco data temporary raised odds of a March rate hike to 44% (currently 38%). We don't expect a March move and feel comfortable by comments of Fed Mester who said that the Fed doesn't want to surprise markets. In the run-up to Trump's phenomenal fiscal stimulus plans (Feb 28?), the US Note future could return towards the December low around 122-14+.

 

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