European stocks rebounded with gains over 2%

Rates

Yesterday’s trading session formed Monday’s session mirror image and emphasizes the volatile market environment. Sentiment turned “risk on” as the situation in Ukraine didn’t deteriorate and Russian president Putin said there’s no immediate need for Russia to invade eastern Ukraine. European stocks rebounded with gains over 2%, US S&P and Nasdaq leapt to new record (cycle) highs. The Russian rubble and currencies like the Polish zloty and Hungarian forint rebounded, oil and gold fell sharply lower, but copper rebounded. Finally, global core bonds sold off. Also here a mirror image with US bonds now underperforming German ones. Both curves bear steepened with US yield changes between 3.2 and 9.7 bps and German yields up between 0.6 and 4.9 bps. The impact of the ECB clearly seen in the small losses at the front end of the euro curve. The US-German 10-yr yield spread is again near cycle highs at 110 bps. Peripheral yield spreads shed up to 11 bps, more than offsetting Monday’s widening. Spain outperformed Italy and Portugal.

Today, the eco calendar is well-filled. According to the first estimate, EMU services PMI increased marginally in February, from 51.6 to 51.7. The final reading is expected to confirm this outcome, but we see risks are for a slight upward surprise. January EMU retail sales are expected to show a rebound by 0.8% M/M, following a drop by 1.6% M/M in December. We see no reasons to distance ourselves from consensus. In the US, the ADP report has been quite a poor forecaster for the payrolls over the previous months. Both in December and January, the ADP report overestimated the actual gain in private sector employment. For February, the consensus is looking for an increase in ADP employment by 155 000, down from 175 000 in January. We believe that the risks remain for an upward surprise and are curious whether the market would react. On Monday, an above consensus ISM was ignored. Finally also the US non-manufacturing ISM will be interesting. The index picked up slightly in January following a weakening at the end of 2013. For February however, the consensus is looking for a drop from 54.0 to 53.5, reversing part of the previous month’s uptick. In January, the index was unaffected by weather conditions and it will be interesting to see whether the same applies for February. As weather conditions appeared to be less severe, the risks are for an upward surprise.

The Fed’s beige book, a preparatory document for the upcoming FOMC meeting, might be more important than usual. It is based on anecdotal evidence assembled by the regional Fed banks.

As the eco data are distorted by the adverse weather conditions of late, the Beige book may give more reliable information on the economy. If the book would paint a very weak picture of the economy, it might have some market impact, but we believe it won’t. Even if it would do, the bar for the Fed to suspend its tapering process in March is probably too high. Of course, it would raise the risk for such suspension at the May meeting on the conditions that hard data would remain very weak.

Today, the German Finanzagentur taps the on the run 5-yr Bobl (€4B 1% Feb2019). It’s the second to last tap of this bond with €9B outstanding. Given the relatively low amount on offer, we believe this auction will be covered unlike the previous two Bund auctions. Total bids at this year’s previous two Bobl auctions were €5.43B and €6.9B (€6.53B average over 2013). The Bobl cheapened around 1 bps in ASW spread terms going into the auction but trades very rich on the 5-yr part of the German yield curve, offering no relative value.

Overnight, most Asian equity indices trade positive though gains are relatively modest given WS’s performance. Chinese HSBC services PMI was marginally stronger than expected as were Australian GDP data. The Chinese leaders made the 7.5% growth target for this year official, but sound more concerned about reaching it. Both US Note future and Japanese yen trade flat, offering no real guidance for the start of Bund trading.

Today, the eco calendar is interesting especially in the US. Risks are for stronger data which is a negative for bonds. On Monday, a stronger manufacturing ISM was ignored in a global risk-off context, but should Ukrainian tensions be quiet as yesterday, stronger data could damage bonds. US treasuries will likely continue underperforming Bunds with tomorrow’s ECB meeting in mind. A first wildcard for trading remains developments in Ukraine where tensions might easily flare up. A second wildcard is the release of the Fed Beige Book (see above).

Technically, the German 10-yr yield remains around the key 1.60% level. Nevertheless, the jury is still out regarding a break. This week, three items will decide on the Bund’s future: Ukraine, the ECB Meeting (Thursday) and US NF payrolls (Friday). This sort of event risk can still cause quite some volatility this week.