Light EMU auction calendar; US refinancing operation

Rates

Potential game changer in French presidential race

Friday's empty eco calendar and the long US weekend ahead set the perfect stage for sentiment-driven trading. In line with the previous two sessions, this translated in corrective bullish action. Core bonds got additional support from a potential game changer in the French presidential election race (see below). Equities opened weak, but made a nice comeback with the S&P matching Thursday's record high. Core bonds ignored the equity recovery. Oil showed some volatility, but closed nearly unchanged. In a daily perspective, the German yield curve bull flattened slightly with yields 3.9 bps (2-yr) to 5.8 bps (30-yr) lower. US yields declined by 1.4 bps (2-yr) to 3.5 bps (5-yr), the belly slightly outperforming.

On intra-EMU bond markets, 10-yr yield spreads versus Germany widened 3 bps for Belgium, 7 bps for France and 8-10 bps for Italy/Spain/Portugal and Greece. The French spread increased to 74 bps, approaching the cycle high (76 bps). France underperformed after Socialist candidate Hamon (15% in the polls) said he discusses with Mélenchon (11% in the polls, far left) and Jadot (2%, Green party) about an agreement on a single presidential candidate. A successful bid could blindside centre/centre-right candidates Macron & Fillon and lead to a surprise confrontation between (extreme) left and extreme right (Le Pen) in the presidential run-off vote. That's the worst case scenario for markets.

 

Market calendar razor-thin with US markets closed

The sole EMU release of the day is the EMU February consumer sentiment. A negligible improvement is expected to -4.8 from -4.9 previously. Consumer sentiment improved very gradual in previous months and nears the highest levels reached in 15 years (-1.4 May 2007, -3.6 March 2015). It shows that the euro area economy is more robust than in past years. Markets usually don't react to the report. The Eurogroup meets on Greece and will evaluate its progress in complying with the terms of the third bailout. The review is 1 year behind schedule and no final conclusion will be reached today, even as progress seems to have made. Chancellor Merkel will hold talks with EU Juncker and IMF Lagarde on Wednesday as divergences with the IMF still blocks the latter's participation. Especially Ms. Merkel, who is behind in the polls for the German elections, needs IMF participation for internal German political purposes. A successful review is essential to get the IMF on board. In July, Greek faces heavy bond redemptions, which without a deal, would lead to insolvency. We expect a solution will be found with the debt reduction question lifted over the German elections.

 

Light EMU auction calendar; US refinancing operation

This week's EMU bond supply comes from Germany and Italy. On Wednesday, the German Finanzagentur taps the off the run 30-yr Bund (€1B 2.5% Jul2044). On Thursday, the Italian debt agency taps zero coupon and inflation-linked bonds. In the US, the Treasury starts its end-of-month refinancing operation tomorrow with a $26B 2-yr Note auction. They continue on Wednesday with $13 2-yr FRN and $34B 5-yr Note auctions and conclude on Thursday with a $28B 7-yr Note auction.

 

Test of 164.90 resistance on the back of EMU worries?

Overnight, most Asian stock markets gain marginally ground with China outperforming (+1%). The US Note future trades with a small downward bias, suggesting a somewhat softer opening for the Bund.

Today's eco calendar is empty apart from EMU consumer confidence, which usually doesn't trigger market reaction. US markets are closed for Presidents' Day, suggesting low volume trading. EMU worries in Italy (Italian PD leadership, early elections (?), financial sector), France (elections) and Greece (no agreement at tonight's Eurogroup) could weigh on sentiment and push the Bund for a new test of 164.90 resistance. We don't anticipate a break higher.

Longer term we hold our negative view for core bond, US investors still have to adapt to the Fed's 2017 rate hike scenario (3 hikes). European investors may face another "recalibration" of the ECB's APP in H2 2017 because of the strong underlying EMU growth (and to a lesser extent) inflation dynamics.

Download The Full Sunrise Market Commentary