Lower EUR stocks & oil: bullish combo for core bonds

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Global core bonds profited from deteriorating risk sentiment on European stock markets, declining oil prices, and central banks’ “lower for longer” attitude, even as stronger US equities limited the Treasury gains and helped equities to juicy gains. The initial positive equity reaction in Asia after the US presidential debate evaporated quickly. Problems at Volkswagen and especially DB remained at the forefront and spoiled risk sentiment bringing fear to the marketplace. Oil prices made another U-turn (lower) as the latest comments from Saudi Arabia and Iran indicated that there wouldn’t be an oil production freeze agreement soon.
Technically, the Bund bravely broke above the sideways range (165.67 top) suggesting a bullish break, which we would like to see confirmed by a drop below -0.20% for the 10-yr yield. EMU M3 money data were higher than expected (5.1% Y/Y), but ignored. US consumer confidence surged unexpectedly higher, while the Richmond Fed manufacturing index remained below expectations at -8. In a daily perspective, the German yield curve shifted 2 to 2.4 bps lower. The US yield curve bull flattened with yields changes ranging between +0.8 bps (2-yr, benchmark change) and -4.2 bps (30-yr). On intra-EMU bond markets, 10-yr yield spreads (vs Germany) widened 5 bps for Italy, Portugal and Greece, while the Spanish spread was unchanged. Italy underperforms Spain because of the dire situation in the nation’s banking sector, while Spain profits from its banking recapitalization in the past.

US eco data & Central bank speakers on the docket

In August, US durable goods orders are expected to have dropped 1.1% M/M following an outsized transportation-driven 4.4% M/M increase in July. Excluding transportation, so-called core durables are expected to have fallen 0.5% M/M, following an increase of 1.3% M/M. Durables are difficult to forecast as only the aircraft orders are known in advance, but often a strong figure is followed by a weak one. Also now it points in that direction as Boeing orders dropped to 22 from 60 in July. So there may be some downside risks. Shipments may be negative as well, as pointed to by the 0.6% M/M August drop in durable output (production report). We think that only a strong report both in headline, core orders and in shipments might have lasting market impact.

Regarding central bankers, Fed Yellen speaks on supervision, which might be interesting after Fed Tarullo suggested that a break-up of major banks shouldn’t be excluded. Fed Bullard and Evans (doves) speak on Community banking (not policy-related), while Cleveland Fed Mester’s (hawk who dissented in favour of a rate hike) views are well known and shouldn’t affect markets much.

Germany and US tap market

The German Finanzagentur holds a €4B 2-yr Schatz auction (0% Sep2018). Total bids averaged €6.39B at the previous 4 Schatz auctions. Even if today’s auction yield could be lowest on record (< -0.69%), we still expect sufficient demand for the relatively low amount on offer. The auction didn’t cheapen in ASW spread terms going into the auction, but is a tad cheap on the German yield curve.

The US Treasury continued its end-of-month refinancing operation with an uneventful $34B 5-yr Note auction. The auction stopped just above the 1:00 PM bid side, with a slightly below average bid cover ratio (2.39). Bidding details showed a pretty good indirect bid, while the direct bid was quite weak. Today, the US treasury ends its refinancing operation with a $28B 7-yr Note auction and a $13B 2-yr FRN auction. Currently, the WI of the former trades at 1.39%.

Bund breaks above upper bound sideways channel

Overnight, most Asian equities can’t keep up with the positive risk sentiment shift on WS. Japan underperforms, losing even up to 1.5%, as USD/JPY remains near key support in the 100-area and many firms notate ex dividend. The US Note future and Brent crude trade stable overnight.

Today’s eco calendar contains US durable goods orders (no market impact expected, see above) and central bank speakers (wildcards). Both ECB president Draghi and Fed Yellen testify before German parliament/House of Representatives. Risk sentiment on equity markets, technical factors (end of quarter buying) and swings in oil prices will remain the most important drivers for core USD/JPY .

Technically, the Bund broke above the upper bound of the post-Brexit trading range (163-165.63). If this break is confirmed by a move of the German 10-yr yield below -0.20%, it’s definitely a bullish sign for the Bund. For now, the break below -0.20% didn’t occur yet though with the German 10-yr yield at -0.14%. A test is nevertheless likely, especially if risk sentiment deteriorates again, meaning that the Bund has more upward potential in the meantime. The trading range for the US Note future is expected to be 130-01+ to 132-05, at least until the first week of October (ISM’s/payrolls) or until Washington-based Fed governors change the tone of their public comments (Oct 14, Yellen speech).

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