Losses on CPI/BoE erased by North Korea

Losses on CPI/BOE erased by North Korea

Global core bonds initially lost ground as the Bank of England signalled "some withdrawal of monetary stimulus is likely to be appropriate over the coming months" and after higher-than-expected US CPI data. Reports in Japanese newspapers about a possible near term North-Korean missile launch erased most of core bond losses via safe haven flows. Eventually, both the Bund and the US Note future ended near opening levels.

At the end of the session, German yields increased by 0.3 bps (2-yr) to 1.2 bps (5-yr & 10-yr). Changes on the US yield curve varied between +1.4 bps (2-yr) and -1.9 bps (30-yr). The front end of the curve underperformed as the market implied probability of a 2017 Fed rate hike moved back above 50% for the first time since early July. On intra-EMU bond markets, 10-yr yield spread changes versus Germany ranged between -2 bps and +1 bp with Greece slightly outperforming (-4 bps).

US eco calendar heats up

Attention turns to the US today. Yesterday's market reaction after stronger US inflation readings proves markets willingness to adapt current dovish positions going into next week's Fed meeting. US headline retail sales are expected to increase by 0.1% M/M following July's impressive 0.6% M/M gain. The underlying trend in consumer spending remains positive, suggesting some upside risks. Gas station sales will be lifted by evacuations for hurricanes while auto sales could be more depressed. The August US empire manufacturing index is forecast to decline from a 3-yr high at 25.2 to 18. Some setback in this notoriously volatile indicator is likely. US industrial production is expected to increase by 0.1% M/M, mainly driven by manufacturing production. The aggregate hours worked by production related factory workers increased by a sharp 0.8% in August. Risks are on the upside of expectations. Finally, Michigan consumer confidence is expected to decline from 96.8 to 95. The indicator remains near multi year highs despite this small forecasted setback. Markets could be more sensitive to the forward-looking inflation components in the report.

US Treasuries sensitive to stronger US eco data?

Asian stock markets trade mixed overnight while the US Note future and Japanese yen fail to gain ground on the North Korea missile launch. The tepid market reaction suggests some habituation from a market point of view to the North Korean missile tests. We expect a neutral opening for the Bund as well.

Today's eco calendar heats up in the US. Data will be key for trading unless European markets do react to the North Korean ICBM test (risk aversion). We don't think they will do so. Risks to US eco data releases are on the upside for the two most important reports (retail sales and industrial production). Yesterday's post-CPI move shows willingness to react. Therefore, we think that there is more downside with US Treasuries underperforming German Bunds. Short covering ahead of the weekend could eventually limit losses. Speeches by ECB Nouy and Lautenschläger are wildcards for trading.

From a technical point of view, US yields recaptured lost support levels and even broke out of their downward trend channels (eg 5-yr & 30-yr). It means that we entered a consolidation phase ahead of the September 20 FOMC meeting, especially if supported by the data. The market implied probability of 2017 Fed rate hike exceeds 50% for the first time since early July, compared with 35% at the end of last week. It still seems too dovish according to us. The FOMC will normally also give the green light at its September meeting for balance sheet tapering in Q4 2017.

Speculation in the run-up to the October ECB meeting (a slowdown in monthly asset purchases and extension APP; start policy normalisation) should cap Bund gains. The Bund tests first support at 161.66

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