Ukraine conflict moved to background, economic data takes the upper hand

Rates

Yesterday, the conflict in Ukraine moved to the background and economic data took the upper hand. A strong upward revision of EMU PMI’s weighed on core bonds in the morning session and complicates the ECB’s decision tomorrow. In the US, ADP and non-manufacturing ISM disappointed, but markets largely shrugged off the weaker data. Does that mean that the bonds are more looking to the downside than to the upside? The Bobl auction was weak, but at least not undersubscribed like in previous auctions. In a daily perspective, US and German yields were flat to 1 bp higher. Peripheral bonds continued to trade very strong. Spreads narrowed by 5, 9 and 14 bps in respectively Italy, Spain and Portugal, amid fresh Spanish supply today.

Today, the focus will be on the ECB meeting and press conference of President Draghi. The eco calendar is rather thin with only German and US factory orders and US jobless claims scheduled for release. On the supply front, Spain (Bono & Obligacion) and France (OAT) will tap the market and Fed’s Dudley and Plosser are scheduled to speak.

After a limited pay-back in December, German factory orders are forecast to have picked up in January. The consensus is looking for a rebound by 0.9% M/M.
We believe that the risks might be for an upward surprise at the start of the new year. In the US, factory orders are forecast to have dropped further in January. The consensus is looking for a decline by 0.5% M/M following a 1.5%. M/M drop in December. Finally, US jobless claims are expected to reverse most of the previous week’s uptick. For the week ending the first of March, the consensus is looking for a decline to 337 000. We have no reasons to distance ourselves from the consensus.

The Fed’s Beige Book showed a quite upbeat picture of the economy. The economy grew in most regions even as harsh winter weather impeded hiring, disrupted supply chains and kept customers away from the shops. More specifically, 8 of the 12 Fed districts reported improved levels of activity, but in most cases improvement was characterized as modest to moderate. NY and Philadelphia reported declines that were mostly attributed to unusual severe weather. The outlook among most districts remained optimistic, the book said.
The book supports the view that the Fed will decide to taper its asset purchases programme by another $10B in March. By the May meeting, it should have more evidence on the economy to reassess the situation.

Today, the Spanish treasury taps the on the run 3-yr Bono (2.1% Apr2017), the off the run 10-yr Obligacion (4.3% Oct2019) and the on the run 10-yr Obligacion (3.8% Apr2024) for a total amount of €4-5B. The bonds on offer didn’t cheapen going into the auction. On the contrary, there was a strong outperformance versus swap, but also versus Italy. Nevertheless given current incredibly positive market sentiment versus periphery, we still think the auction will go well amid valuations.

Mr. Draghi signalled after the G-20 meeting that the ECB would have all necessary information to take decisions when it meets today. During February , ECB comments clearly increased the momentum for an additional easing of policy. We were positioned for such an easing and enjoyed the shift in sentiment. However, recently, the momentum faded, not because of ECB comments (there were none in that direction), but because the February inflation data surprised and the latest eco data are at the margin encouraging.
In our flash report we elaborate on the foundations of our view the ECB would ease policy. We tipped on a lowering of the refi-rate to 10 bps combined with a negative deposit rate, as a clear ECB signal that it meant business in fighting too low inflation for too long. We stick to our expectation. Given recent data releases and resistance of the Bundesbank against a negative deposit rate, a suspension of the SMP sterilization might be a compromise. If the ECB would refrain from taking any new measure, it would be difficult for them to take more decisions for at least three months and make them vulnerable in case inflation would remain too low.

Overnight, most Asian equity indices trade positive with a Japanese outperformance (weaker yen). Australian retail sales were better than expected. The US Note future trades with a very modest downward bias, perhaps suggesting a slightly lower opening for the Bund.

Today, all eyes will be on the ECB meeting. We believe that a small refi rate cut or even a negative deposit rate is largely discounted in bond prices. In case of inaction or such small policy measure, bonds can even lose in a buy-the-rumour, sell-the-fact manner. Therefore, we only see more upward potential should the ECB stop sterilizing its SMP bond portfolio or go viral and announce a blueprint for outright QE (very unlikely though).

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.