Peripheral bonds and US stocks sell-off

KBC Market Research Desk KBC Bank

Global core bonds gained ground yesterday as (US) stock markets and peripheral bonds nosedived. US equity markets took a 1.25% (Dow) to 2% (Nasdaq) hit. German Bunds outperformed US Treasuries. German yields declined by 3.5 bps (30-yr) to 4.8 bps (5-yr) with the belly outperforming the wings. US yields lost 0.8 bps (30-yr) to 3.1 bps (5-yr) with the curve shifting in parallel fashion. Peripheral yield spreads vs Germany widened by 12 bps (Spain) to 18 bps (Italy) after the EC officially informed Italy that its budget plans are at risk of non-compliance. The Italian spread hit a 327 bps cycle high. Italy has until early next week to formally adapt changes, but combative language by political heavyweights suggests no intention to do so. The EC in that case can for the first time ever issue a negative opinion, essentially rejecting the budget and asking Italy to revise it.

Most Asian stock markets lose ground overnight, but the damage isn't similar to WS's slaughter yesterday. China opened on a bad footing as well following mixed eco data. Q3 GDP printed at 1.6% Q/Q and 6.5% Y/Y (vs 6.6% Y/Y expected) with stronger retail sales and disappointing industrial production. The numbers count as a signal in the trade war. Chinese bourses nevertheless rebounded rapidly into positive territory following joint verbal interventions by top regulators and the PBOC governor. They promise measures to help ease financial pressures on companies. The US Note future trades with a small downward bias, but we think the Bund could open stronger on early equity weakness.

Today's eco calendar is empty apart from speeches by Atlanta Fed governor Bostic (dove) and by Dallas Fed governor Kaplan (neutral). They won't inspire trading. Risk sentiment on stock and peripheral bond markets is key. There's no compelling case to either expect yesterday's hiccup to last, nor for a strong rebound. We slightly favour the former scenario. From a technical point of view, the US 10-yr yield retested previous resistance around 3.12%. The yield remained above this level, strengthening the break and suggesting more upward potential in the medium term. The cycle high stands at 3.26%, but next real key resistance only kicks in around 3.75%. The German 10-yr yield lost minor support at 0.48%. Strong support kicks in at 0.41%/0.42%. These levels will be tested today. We don't anticipate a return lower.

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KBC Market Research Desk

KBC Bank

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