Improving risk sentiment, but core bonds resilient

Global core bonds oscillated near opening levels yesterday with US Treasuries slightly underperforming German Bunds. Core bonds put up a decent performance given the further improvement in risk sentiment with US stock markets eventually gaining around 1%. The oil price deepened losses intraday, but rebounded into the close. US CPI inflation moves further above the Fed’s 2% goal, both for the headline (2.9% Y/Y) and core (2.3% Y/Y) measure and explains the further flattening of the US yield curve. US yield changes ranged between +0.8 bps (2-yr) and -0.6 bps (30-yr). The US 2-yr yield tested the 2.6% cycle top. German yields declined by 0.2 bps (30-yr) to 1.5 bps (5-yr). 10-yr yield spread changes vs Germany narrowed up to 2 bps yesterday with Italy outperforming (-5 bps) after a good BTP auction.

US Fed chair Powell appeared in a radio interview just before the US close. He said that the US economy was in a very good position right now. It could profit the next three years from the fiscal boost from tax reforms and spending. That should allow the Fed to gradually keep raising interest rates. The market implied probability of a September rate hike amounts 86%. The chance of two more hikes this year, our preferred scenario, is around 60%. In his most direct comments on the issue so far, Powell warned on a worst case stagflation scenario resulting from a trade war. The Fed chair testifies on Capitol Hill next week in semi-annual congressional hearings.

Asian stock markets build on WS gains with Japan outperforming on a weaker yen. The Chinese trade surplus hit the highest level since December, but catch remarkably few headlines. The US Note future treads water. Powell’s comments have no direct market impact. We expect a neutral opening for the Bund.

Today’s eco calendar is thin with US import/export prices and Michigan consumer confidence (July). Price are second tier following US PPI and CPI earlier this week. Michigan confidence is expected to stabilize near historically high levels. The trading session could be colored by the start of Q2 earnings season with major US banks posting results. The US S&P 500 tested 2800 resistance, the final hurdle before the all-time high at 2872. A break higher would further improve risk sentiment and could extend the topping off pattern on core bond markets with US Treasuries underperforming German Bunds. Technically, the German 10-yr yield tested support just below 0.3%. A break didn’t occur, suggesting room to move higher in the 0.3%-0.5% range. The US 10-yr yield hovers near the middle of the sideways range between 2.71% and 3.12.

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