Improving risk sentiment hits core bonds

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Improving risk sentiment hits core bonds

Global core bonds extended the decline which started on Friday afternoon, but the pace slowed. Risk sentiment on stock markets remained positive with new closing highs for the three main US indices. Stronger than expected, but second tier, eco data and EMU/US supply (including €3.5B 100-yr RAGB) were additional negatives for core bonds. Monday’s technical breaks of US yields back above previous support levels (5-yr: 1.7%, 10-yr: 2.1%, 30-yr 2.68%) were confirmed and suggest that the downtrend since the start of the Summer is over. We might have entered a consolidation phase ahead of next week’s FOMC meeting. Markets are still too dovish positioned according to us with US rate markets not even discounting a complete rate hike by the end of 2018.

At the end of the session, the German yield curve bear steepened with yields 2.4 bps (2-yr) to 7.3 bps (30-yr) higher. US yields closed 1.6 bps (2-yr) to 3.7 bps (10-yr) higher. Traded volumes in US Treasuries were rather high for a Monday, giving the move more significance. On intra-EMU bond markets, 10-yr yield spread changes ended close to unchanged with Greece (-8 bps), Portugal and Spain (-3 bps) outperforming.

US PPI and ECB Praet are wildcards for trading

Today’s eco calendar remains rather thin, but we keep a close eye on US PPI data. Consensus expects a 0.3% M/M gain in August (2.5% Y/Y). A confirmation or upward surprise could extend the correction lower on core bond markets. Compared to last week, we think that core bonds are less sensitive to a weaker outcome. Global inflation readings generally tended to beat consensus lately. July EMU industrial production is forecast at +0.1% M/M, but the outdated numbers won’t impact trading. National numbers have already been released and showed a 0.3% M/M decline in Spain, a flat outcome for Germany, a 0.1% M/M increase in Italy and a strong 0.5% M/M gain for France. ECB chief economist Praet is scheduled to speak in Frankfurt after the European close. Praet is a member of the more dovish wing inside the ECB. Any comments on the single currency or intentions on the October ECB-meeting (how will the future of APP look like?) could influence dealings.

Germany, Italy and the US tap market

The German Finanzagentur taps the on the run 10-yr Bund (€3B 0.5% Aug2027). Total bids averaged €3.99B at the previous 4 Bund auctions and we don’t expect much improvement today with investors probably fearing policy normalisation speculation (higher yields) in the run-up to the October ECB meeting. The Italian Treasury launches a new 7-yr BTP (€3.5-4B 1.45% Nov2024) and taps the on the run 3-yr BTP (€2-2.5B 0.35% Jun2020) and 20-yr BTP (€1-1.5B 2.25% Sep2036). Grey trading suggests that the new BTP will be priced with a 7.3 bps pick-up in ASW spread terms compared with the previous 7-yr benchmark (1.85% Oct2023). That corresponds with a 17 bps pick-up in yield terms. The other two BTP’s traded rather stable in the run-up to the auction, but the Sep2036 BTP sits rather cheap on the Italian curve. The US Treasury continued its refinancing operation yesterday with a poor $20B 10-yr Note auction. The auction stopped with a full basis point tail and the bid cover was the second smallest since last November (2.28). Bidding details showed little interest across the line (dealer, direct and indirect bid). The Treasury ends its refinancing operation today with a $12B 30-yr Bond auction. The WI trades currently around 2.76%.

Can US eco data start a 2nd downleg in US T’s this week?

Asian stock markets trade mixed overnight despite new closing highs for the three main US indices last night (+0.4%). The US Note future has a small upward bias, suggesting a somewhat higher opening for the Bund as well.

Today’s eco calendar contains US PPI data and EMU industrial production. PPI could influence trading, especially in case of an upward surprise. The US supply operation remains negative for US Treasuries. Improving risk sentiment drove core bonds lower over the past days, but we think that the risk rally could slow. Upbeat US eco data are probably needed now to add a second downleg (US CPI, US retail sales, industrial production,… later this week). From a technical point of view, US yields recaptured lost support levels (see above). If confirmed, it suggests that we probably entered a consolidation phase ahead of the September 20 FOMC meeting. Last week’s safe haven flight could in retrospect be considered as an exhaustion move with markets now too dovish positioned given that the FOMC will normally announce the start of BS tapering and that they might keep a December rate hike on the table.

Speculation in the run-up to the October meeting (a slowdown in monthly asset purchases and extension APP; start policy normalisation) should cap Bund gains. ECB Praet’s speech is in this respect a wildcard for trading.

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