Over to the ECB

KBC Market Research Desk KBC Bank

Global core bonds ended higher last Friday with German Bunds outperforming US Treasuries. Thursday's violent profit taking on core bonds (more neutral positioning going into ECB/Fed meetings) didn't continue. Mixed US payrolls called off the downside alert. Fed Chair Powell in a speech in US trading did nothing to alter current market expectations of a September rate cut. The US yield curve flattened with daily changes ranging between +1.5 bps (2-yr) and - 2.4 bps (30-yr). The German yield curve bull flattened with yields declining up to 7.3 bps (30-yr). Both the German 10-yr and 30-yr yield failed to close the week above first minor resistance, respectively at -0.61% and 0%. 10-yr yield spreads vs Germany narrowed by up to 2 bps with Greece underperforming (+5 bps).

Most Asian stock markets are in positive territory this morning with Japan and China outperforming. Core bonds trade listless. Eco/event news is thin apart from and unexpected contraction in China's exports in August.

Today's eco calendar is razor thin with only German trade data. Things don't improve on this front tomorrow and on Wednesday, leaving a void between now and Thursday's ECB meeting. Market sentiment will be responsible for intraday gyrations, but probably won't cause technically relevant moves. The US Treasury's mid-month refinancing operation is an exception to the rule which could cause some underperformance of US Treasuries vs German Bunds.

Regarding the ECB meeting, we expect President Draghi to deliver on his July "promise" to ease monetary policy. More specifically we expect a 10 bps deposit rate cut, possible with a tiered system, and an extension of current forward guidance to keep rates lower for longer. The money market is currently split on whether the ECB cut will be one by 10 bps (55%) or by 20 bps (45%). Some analysts expect the ECB to engage into a new asset purchase program as well, but that's not our base scenario. Overall, we think it might be hard for Draghi to deliver on very dovish market expectations. Recent ECB speeches suggest growing consciousness within the central bank about negative side-effects from additional easing.

September ECB (12) and Fed (18) meetings will probably lock/shape policy for several months ahead. The German 10-yr yield last week tried to return above first minor resistance (-0.61%), but a sustained break higher, necessary to call off the downside alert, didn't occur. Similar resistance for the US 10-yr yield kicks in around 1.6%. On the downside, key levels are 1.44% and 1.32% (all-time low).

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KBC Market Research Desk

KBC Bank

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