Germany, Portugal and US tap market

Rates

US curve bear flattens, as Dec hike looks unavoidable

Yesterday, global core bonds ended narrowly mixed after trading with a negative bias during the European morning session. German bonds ended slightly lower, while US Treasuries turned lower at the short end of the curve and higher at the longer end. The probability of a US December rate hike increased to 72.5% without a strong driver. Weaker consumer confidence helped US Treasuries in US mid-morning recover from European-induced weakness, but the gains evaporated and the US short end was hit again after a weak 2-yr US Note auction, another sign that investors expect a Fed rate hike in December. Supply weighed already on core bonds in European trading (70yr Austria deal; UK 50-yr). The EMU eco calendar contained a strong German IFO-indicator, which was ignored completely. Equities and oil traded initially sideways but both fell in US mid-morning, helping US Treasuries to recover. In a daily perspective, changes on the German yield curve ranged between -0.1 bp (30-yr) and +1.2 bps (5-yr). US yields changed between +1.2 bps (2-yr) and --1.9 bps (30-yr) lower. On intra-EMU bond markets, 10-yr yield spread changes versus Germany ended nearly unchanged with Greece outperforming (-3 bps) and Portugal underperforming (+3 bps).

Eco calendar unattractive

In EMU, French consumer confidence is expected slightly higher in October (98 versus 87), but it won't affect markets. In the US the dataflow is busier with the Sep Goods trade balance, the Oct. Markit Services PMI, the Sep wholesale inventories (Sep) and the Sep New Home sales. We don't expect these to change the environment for core bonds in a lasting way. The markets expect a small widening of the trade deficit and a minimal increase in the wholesale inventories, which might cancel each other out in terms of impact on Q3 GDP. The Sep New Home sales are likely the most important release. A small 1.5% decline to 600K is expected in September, following an already steep 7.6% decline in August. However July and the months before were strong. The level of 600K (Sep) should still be the third highest of the cycle and up from 457K one year ago. Following a strong manufacturing PMI (Markit) a slight 0.2-point increase in the October services PMI (52.5) is expected.

Germany, Portugal and US tap market

The German Finanzagentur holds a small Bobl auction (€3B 0% Oct2021). Total bids averaged €4.51B at the previous 4 Bobl auctions. The bond trades stable in ASW spread terms going into the auction, but is cheap on the German curve compared to surrounding off the run bonds. We expect a plain vanilla auction given the small hurdle to clear (€3B). The Portuguese debt agency taps the off the run OT (3.85% Apr2021) for €0.75-1B. With DBRS's rating decision out of the way, we expect good demand today. The bond offers a significant pick-up over swap/other peripherals given its relatively short maturity. The US Treasury started its end-of-month refinancing operation with a weak $26B 2-yr Note auction. The auction stopped with a slight tail and the bid cover (2.53) was light. Bidding details showed very little buy-side interest, anticipating a December Fed rate hike. Today, the Treasury holds a $15B 2-yr FRN auction and a $34B 5-yr Note auction. Currently, the WI of the latter trades around 1.27%.

Looking to oil and equity markets today?

Overnight, Asian stock markets lose more ground than WS yesterday evening as Apple stocks are down in after-trade following disappointing results. Brent crude slides towards $50/barrel mark as more and more non-OPEC members bail out on the production cut agreement. Despite weaker stocks and oil, the US Note future trades stable overnight. Today's eco calendar is uneventful suggesting sentiment-driven trading. If stocks and commodities remain under downward pressure it could slightly underpin core bonds within their established ranges. Nevertheless, in the run-up to next week's FOMC meeting, the US Note future could test 129-26 support again, anticipating hints on a December move. Yesterday, the market implied probability of December rate hike increased to 72.5%. In such scenario, the US 10-yr and 30-yr yields should be able to hold above key resistance levels at 1.75% and 2.5% though. Earnings could influence core bond markets via risk sentiment. We think that the correction higher in the Bund following the ECB meeting has run its course. ECB president Draghi said that the ECB will deliver key policy guidance in December. QE won't last forever, but also won't stop immediately after March 2017, suggesting that the central bank has a tapering scenario in mind, but not necessarily just after March. We expect the Bund to remain in the sideways trading range (163 area – 165.63).

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