Steepening German/US yield curves

Global core bonds traded in a narrow sideways range yesterday. US Treasuries underperformed after European close on headlines that US President Trump was readying an infrastructure plan for January release. The proposal would aim to generate $1 tn in total investment. More or less simultaneously, House speaker Ryan suggested that the GOP had the votes to fund the government passed this weekend's funding deadline. Eventually, they did so by passing legislation to keep the government running until December 22. Second tier eco data (disappointing German industrial production, confirmation EMU Q3 GDP and strong jobless claims) didn't play a role. Risk sentiment on equity and commodity markets improved.

In a daily perspective, the German yield curve steepened with yield changes varying between -1.2 bps (2-yr) and +1.7 bps (30-yr). The underperformance of the very long end was due to ministry of finance comments about next year's funding (possibility of 50y Bund and continued reliance on 30y Bunds). The German 10-yr yield closed just above key support for a second straight day. The US yield curve steepened as well with yield changes ranging between -0.4 bps (2-yr) and +3.1 bps (30-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany ended unchanged with the periphery outperforming (2 to 6 bps spread narrowing).

Today's eco calendar heats up in the US with the November payrolls report. Consensus expects a net job gain of 195k, following the post-hurricane rebound in October (261k). The unemployment rate is forecast to stabilize at 4.1%, the lowest level since 2000 and below the Fed's NAIRU estimate (4.6%). Average hourly earnings are expected to post a good acceleration (0.3% M/M and 2.7% Y/Y). Almost every other recent indicator about the US labour market continued to point at strength, which we expect to be confirmed by today's payrolls.

 

White smoke on political scene and strong (?) payrolls

Risk sentiment is positive overnight with China and Japan gaining more than 1% following strong regional data (Japanese GDP & Chinese trade balance). Developments on the US and European political scene boost sentiment further. The US government agreed a short-term measure to delay to secure government funding from this weekend to December 22. EC Juncker and UK PM May reached a deal on phase 1 of the Brexit talks. The US Note future cedes more ground, suggesting a lower opening for the Bund as well.

The eco calendar heats up today with US payrolls. We expect more signs of strength from the US labour market. A stronger or in line with consensus outcome should be sufficient to inflict losses on US Treasuries. That should especially be the case if the outcome reaches the consensus on earnings (0.3% M/M & 2.7% Y/Y). Markets are for the first time this tightening cycle moving towards the FOMC's projections. They currently already discount 2 rate hikes for next year (vs 3 dots). In case of strong payrolls, more repositioning could be possible going into next week's FOMC meeting. Improving risk sentiment and strong data explain our downward intraday bias, with US Treasuries potentially underperforming Bunds.

Technically, US Treasuries will probably trade in the 123-27 to 125-14+ range going forward (March 2018 contract!). This corresponds with a 2.3%-2.47% band in yield terms. The German Bund set a new contract high, but this wasn't confirmed by a drop of the German 10-yr yield below 0.3%, although the test is ongoing. We don't anticipate such move and suggest putting short positions around current levels. Strong current and expected growth and the ECB's slow normalisation process warrant such move.

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