Global core bonds sold off on Friday

Rates

Global core bonds sold off on Friday, as the February payrolls report beat expectations. US yields were up to 6.8 bps higher in the belly of the curve. The reaction on the German market was of course more muted. Furthermore, after the initial sell-off, the Bund managed to recoup almost all losses. At the end of the session, yield changes on the German curve ranged between -0.1 bps (30-yr) and +1.5 bps (2-yr). The 10-yr yield spread between the US and Germany rose to a cycle high of 113 bps. On peripheral bond markets, spread narrowing continues. Belgium lags on the back of rumours of a new 15/20-yr syndicated deal next week.

Today, the US eco calendar is empty and also in the euro zone, the economic calendar is thin with only several national industrial production data on the agenda. Euro area Finance Ministers meet in Brussels and Fed’s Evans and Plosser and ECB’s Noyer and Costa are scheduled to speak.

On Friday, German industrial production data came out in line with expectations, increasing by 0.8% M/M, while the December data were upwardly revised. Strength was led by the construction sector, while manufacturing production increased by 0.3% M/M. Both French and Italian production are forecast to have rebounded too in January and we expect the same for Spanish production. While a rebound is likely for the manufacturing sector, this might be partly offset by a decline in output of utilities due to unusually warm weather.

Rating agency Moody’s raised the outlook on the Belgian Aa3 rating and on the Dutch Aaa rating from negative to stable. Moody’s cites diminished risks that Belgium’s government balance sheet will be affected by more contingent liabilities stemming from the banking sector and expectation that fiscal consolidation will continue as the main drivers behind the decision. The latter should support a reversal in government debt at around 100% of GDP in 2014-2015. Last week, also rating agency S&P raised the outlook on the Belgian rating from negative to stable. We believe this will be slightly supportive for OLO’s today. Should Friday’s rumour of a new syndicated deal be confirmed, the rating action can also be helpful for demand.

This week’s scheduled EMU bond supply comes from the Netherlands, Germany, Italy and possibly Ireland. Tomorrow, the Dutch debt agency taps the on the run 3-yr DSL (€2.5-3.5B 0.5% Apr2017). On Wednesday, the German Finanzagentur taps the on the run 2-yr Schatz (€4B 0.25% Mar2016). On Thursday, there is an Italian BTP auction (lines and auction sizes to be announced) and Ireland has the possibility to hold its first tap auction since 2010. On Friday, there were rumours of a tap of the 10-yr bond (3.4% Mar2024). This week’s auctions won’t be supported by bond redemptions.

In the US, the treasury holds its mid-month refinancing operation. They start tomorrow with a $30B 3-yr Note auction, followed by a $21B 10-yr Note auction on Wednesday and a $13B 30-yr Bond auction on Thursday.

Overnight, most Asian equity indices trade negative with China underperforming (losses >3%). This weekend, Chinese trade data showed a huge drop in exports though the data might be skewed by Lunar New Year Holidays. Japanese Q4 GDP data were downwardly revised. The US Note future trades with a modest upward bias suggesting some mild risk-off at the start of trading, which is positive for the Bund.

Today, the eco calendar is thin (see above) and unlikely to influence bond markets. Therefore we hold a neutral bias for today’s trading session.
The situation in Ukraine remains a wildcard. After European market closure, the Eurogroup meeting is expected to conclude. Topics of debate are the economic situation in EMU, the ESM direct bank recapitalisation instrument and updates on the Greek, Cypriot and Portuguese adjustment programmes, but no major decisions are expected.

Following last week’s payrolls report, the US Note future tested the downside of its recent trading channel (123-15+; 2.78% in yield terms). A break below would change the technical picture, but given the thinness of the calendar this week we believe that we might have to wait on Thursday’s retail sales to see such a move possibly happening. The German Bund future outperformed last week and is now in the middle of the recent trading range. Given the outcome of last week’s ECB meeting, we believe the upside is blocked and eventually eye for a return towards 141.20 (downside recent range). A sell-on-up ticks strategy is preferred in case bonds fall below the downside of these ranges.