Core bonds continue to rally

Rates

Yesterday, global core bonds initially kept a sideways trading profile, but mid-morning in the US rallied, as equities got temporarily whacked by a large sell order in a thin market, something we might see more now that summer holidays kick in. Equities recovered afterwards, supporting the view the decline wasn’t triggered by specific events, but core bonds safe-guarded a large chunk of the gains, even as a weak US 7-year Note auction left some traces on the charts. Technical buying in core bonds played a role too, as some resistances fell, while talk of month-end extension buying flared up. US eco reports on the contrary came in near expectations and had only limited impact. In Germany, yields were up to 3.1 basis points lower, the belly of the curve outperforming.
Peripheral yield spreads widened very slightly.

Today, the euro zone eco calendar heats up with the European Commission’s confidence indicators and inflation data in Germany, Spain and Belgium. In the US, the final reading of June Michigan consumer confidence will be released. EU leaders will continue their two-day Summit in Brussels, the ECB will announce the amount of LTRO repayments and Italy will tap the market (BTP & CCTeu).

In May, German HICP inflation dropped to its lowest level in more than four years, to 0.6% Y/Y. For June, a limited pick-up to 0.7% Y/Y is forecast (0.2% M/M). June inflation data are often subject to high volatility due to the summer sales and large price swings in leisure & entertainment ahead of the holidays. As a result, it is difficult to make accurate forecasts, but we believe that the risks might be for an upward surprise in Germany, probably also due to higher energy prices. In Spain, inflation is forecast to have slowed further in June, from 0.2% Y/Y to 0.1% Y/Y, while there is no Bloomberg consensus available for the Belgian CPI data. Also in the euro area, European Commission’s consumer confidence is forecast to extend its upward trend in June, albeit at a slow pace. The consensus is looking for an increase from 102.7 to 103.0. We are however cautious after some disappointing confidence indicators earlier this month, for example EC’s consumer confidence, and believe therefore that a downward surprise is likely. Sentiment might have improved further in the peripheral countries, but we expect that it will be offset by weakening sentiment in the core countries. In the US, the final reading of Michigan consumer sentiment for June is expected to show an upward revision, from 81.2 to 82.0. Despite the strong Conference Board’s reading, we believe that any upward revision will be small as higher gasoline prices might weigh on sentiment.

The US 7-year Note auction didn’t go well. The 7-year stop-out rate of 2.152% was 1.2 basis points above the bid in the WI at the time of the stop. The bid/cover of 2.44 was below the average of, but below the bid/covers of the past auctions. The buy-side bidding details were also weak, especially the Direct bid and a 16.7% takedown was the smallest this year. The Indirect bid was better, but not aggressive leading to a 40.6% takedown, slightly higher than the previous month, but nevertheless below average. This left dealers with the largest takedown (42.7%) this year.

The Italian Treasury holds its BTP (and CCTeu) auction. It will issue a new 5-year 1.5% August 2019 for a targeted amount of €3-4B and tap its benchmark 3.75% September 2024 for an amount of €2-to-2.5B. The BTP was first issued early March and has currently a volume of €14.451B. The Treasury will also sell a November2019 floater (€1-to-1.5B) The Italian-Spanish 10-year spread remained close to 20 basis points in recent days, which seems a bit too wide and thus may be a positive for the auction.

Overnight, Asian equities trade weak, especially as US equities ended nearly unchanged, recouping losses throughout the session. Treasuries are a bit firmer, while the yen strengthens versus the dollar. So, there is a whim of risk-off in the air.

Regarding bond market today, the calendar is mixed from a bond perspective. Risks on higher German inflation, but weakness in EC confidence. Michigan consumer confidence might disappoint, but only slightly (final reading). The EU Summit might give spectacle as UK PM Cameron is facing a humiliating defeat, but for markets it isn’t of immediate interest. Month-end extension buying is a positive, as is the upcoming weekend with markets nervous and equity profit taking a possibility. The ST technical picture for Bund and US T-Note future became again bullish in recent days. In this context, we think core bonds should continue to trade constructive today. Of course, vertigo may at some point kick in, as well as the key 1.47/40% support for the US 10-year, but overall there a few signs that core bonds are near exhaustion.

For US Treasuries, the Note future closed above the top of its tight ST sideways range (123-25- 124-23+/25+) and again above the uptrendline (124-28+ today). The 10-year yield is near the key 2.46/40 support. A drop below would be technically very relevant. The Bund has broken above the upper bound on its sideways range and the 10-year German yield is below the 1.29% low. Concluding, the technical picture for the Bund remains bullish and the ST picture for the US Treasury Note became bullish.