Risk-on correction lower in core bond markets

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Risk-on correction lower in core bond markets

Global core bonds lost ground yesterday in a risk-on environment. USD/JPY eked out nice gains and European equity markets added up to 0.5%. The move mainly occurred in the European session with once again an outperformance of German Bunds vs US Treasuries (dovish ECB expectations & European political risk). The eco calendar only contained weaker-than-expected, but distorted, US housing data. ECB Lautenschlaeger and Villeroy both suggested ending QE next year. This is perfectly possible in the currently rumoured extension (to September 2018) and recalibration (from €60 bn/month to €30 bn/month). Heavyweight NY Fed President Dudley sounded confident in the US economy and holds on to a 3-rate hikes scenario this year (one additional hike).

At the end of the day, the US yield curve bear steepened with yields 1.7 bps (2-yr) to 5.4 bps (30-yr) higher. Changes on the German yield curve ranged between +0.6 bps (2-yr) and +3.1 bps (10-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany ended close to unchanged with Spain underperforming (+4 bps) ahead of today’s supply and Catalan President Puigdemont’s answer to Madrid on independence.

Eco calendar unenticing, eyes on Catalunya

Main attention goes to Spain today. Catalan President Puigdemont has until 10 am local time to formally declare or withdraw independence. Madrid indicated to trigger article 155, stripping the region from its autonomy, if he pushes through with the independence call. Dialogue is only possible if Catalunya withdraws its statement, according to PM Rajoy. We fear that tensions might escalate with an unknown outcome (new Catalan elections?). Such a context could cause underperformance of Spanish assets while the Bund might profit. The eco calendar contains US weekly jobless claims and October Philly Fed Business Outlook. Jobless claims are expected to stabilize near 240k and are probably no longer distorted by the Hurricanes. A small decline is forecast for the Philly Fed Index (23.8 to 22), but the volatile index remains near the highest levels. We don’t expect the data to influence trading. The ECB’s black-out period kicks in ahead of next week’s key policy meeting. Kansas City Fed George speaks on the economy, but her hawkish views are well-known.

France and Spain conclude scheduled EMU bond supply

The French treasury taps two on the run OAT’s (0% May2021 & 0% Mar2023) and an off the run OAT (1.75% Nov2024) for a combined €6-7bn. The amount on offer is relatively low and should be easy to digest. We expect a decent auction. Additionally, the French Treasury wants to raise €1.25-1.75 bn via three inflation-linked OAT’s. The Spanish debt agency sells three on the run bonds (0.05% Jan2021, 1.45% Oct2027 & 2.9% Oct2046) and one off the run Obligacion (4.65% Jul2025) for a total amount of €4-5 bn. The timing of the Spanish auction isn’t the best one. Catalan President Puigdemont needs to declare/withdraw independence ahead of the auction. We fear that he won’t give in to Madrid demands, causing risk aversion and volatility in Spanish bonds by the time of the auction. Therefore, we fear that many investors will decide not to participate in today’s auction.

Shun Catalan political risk

Asian stock markets trade mixed overnight with China underperforming (-0.50%) despite robust Q3 GDP data. The US Note future trades stable and we expect a neutral opening for the Bund.

Eco data and central bankers won’t impact trading today. The Catalan-Madrid stand-off could escalate to a new phase (see above). Cautiousness might be warranted. The Bund might profit in a daily perspective, with more outperformance vs the US Note future while Spanish spreads could widen. Q3 earnings are a wildcard for trading via stock markets. US and German indices are at all-time highs, suggesting they are prone for a correction.

Technically, the German Bund broke above the 162 mark, implying a full retracement towards the contract high. European election outcomes (Germany, Austria, Catalonia) and ECB rumours caused outperformance vs the US Note future. We hold a sell-on-upticks strategy in the US Note future (entry around 126), but put it on hold for the bund.

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