Important test of bond sentiment with US payrolls

Rates

Core bonds resilient as investors await US payrolls

Yesterday, global core bonds moved according to script until European noon. Equity and oil prices gradually rose, pulling Bunds and US Treasuries somewhat lower. ECB’s Draghi urged that it’s too early to speculate on an ECB exit as the central bank needs sufficient confidence that inflation converges to the ECB objective. Apart from some minor losses for the euro, markets ignored his comments. During US trading, core bonds again showed their recent resilience. They changed direction, even if intraday trends higher on stock and commodity markets were extended. On top, US weekly jobless claims unexpectedly declined towards the cycle low and ECB Minutes showed that divergence inside the ECB is larger than president Draghi indicated in the morning. They eventually decided to keep forward guidance unchanged as changing it could backfire on markets. SF Fed governors Williams confirmed that the Fed could start winding down its balance sheet towards the end of the year, something which was revealed when the Minutes were published Wednesday eve.

In a daily perspective, the German yield curve marginally bull flattened with yield changes ranging between +1.7 bps (2-yr) and -0.9 bps (30-yr). Changes on the US yield curve varied between 1.2 bps (2-yr) to 2.3 bps (30-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany moved between -5 bps (Ireland/Portugal) and +1/2 bps (Spain/Greece). The French debt agency successfully launched a new 10-yr OAT, while the Spanish auction was plain vanilla. French bonds slightly outperformed their Belgian peer (10y).

All attention for the March US payrolls

Payrolls started 2017 on a strong note with employment gains of 238K and 235K in January and February, which signalled an acceleration from Q4 2016 average of about 150K. We expect that the labour market remained healthy in March, but somewhat less buoyant. Indeed, the increases in January/February might have been partly helped by unusual mild seasonal weather conditions. So, construction and manufacturing may be sources of some moderation. The ISM and the Markit manufacturing PMI employment sub-indices though gave contradictory signals. The market expects a 180K net job gains. We got some divergent signals with a bumper ADP private employment report, but an easing of the Non-manufacturing ISM employment sub-index and some increase in the relevant initial claims statistics (even if these might have been distorted on the upside given the sharp drop in the last week’s claims).

Regional labour market indications remained strong. So, we would nevertheless put the risk somewhat to the upside of expectations with the 6m and 12m average of 195K as our guesstimate. The unemployment rate might have stabilized at 4.7%, while we hope to see earnings to have stabilized at 2.8% Y/Y (consensus 2.7% Y/Y).

Important test of bond sentiment with US payrolls

Overnight, risk sentiment deteriorated after the US launched a missile attack against Syria. The US Note future spiked higher with the US 5-yr (1.8%) and 10-yr (2.3%) yields testing key support. A break didn’t occur. Rising oil prices partly dampened the gains. We still expect a higher opening for the Bund though.

The missile attack will grab the headlines at the onset of dealings, but we don’t expect risk aversion to go far. Later, focus turns to US payrolls. Risks are on the upside with expectations. The unemployment rate and average hourly earnings will also be closely monitored. We expect the overall report to be strong enough to reinforce the lower boundary (in yield terms) of sideways trading ranges for the 5-yr yield (1.8%-2.14%) and 10-yr yield (2.3%-2.64%). The test of these bottom levels could be used to offload bonds or position for higher rates. Markets still have to align with the Fed’s tightening scenario and didn’t take into account effects of the start of the run-off the balance sheet ahead of the year-end. Our hypothesis will be tested in case of a disappointing outcome. Nevertheless, even in that scenario, we expect the Fed to proceed with monetary normalisation as planned with eventually higher US yields as a result.

The German 10-yr yield is declining in a similar sideways range (0.2%-0.5%). We take a same approach as for US Treasuries and don’t anticipate a decline below 0.2%.

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