The curve nicely flattened in both markets

Rates

On Friday, global core bonds erased large part of Thursday’s losses in a thinly traded, quite dull session. A surprisingly weak German IFO was ignored, while mixed to weaker US durables had a limited positive impact. Equities weakened during the morning session, which did support bonds, lingering in a tight sideways range in the European afternoon session. Equity weakness and end of week buying (safe haven) may have been the motives behind the daily gains. It keeps the Bund near the highs and the 10-yr German yields near all-time lows. German yields were up to 3 bps lower, while US yields were flat to 5.7 bps lower. The curve nicely flattened in both markets.

Today, the eco calendar is very thin, both in the US and euro zone, with only second-tier data as the US pending home sales and Markit services PMI. Italy (CTZ & BTPeis) and the US (2Yr Notes) will tap the market. After weakness in the second half of last year and early this year, US pending home sales showed signs of improvement in the previous months. Pending home sales increased already for three consecutive months, but a stabilization is expected in June. Recently, housing data have been mixed. In June, new home sales dropped sharply while existing home sales rose for a third consecutive month. For pending home sales, we believe that a limited pay-back is likely.

Later this week, the calendar is enticing, especially in the US. Attention will go to the FOMC meeting, but most likely markets won’t get fresh information. There is no press conference scheduled and recently Yellen gave the green light for risk taking, suggesting that monetary policy won’t be used to reign in increased risk taking in a limited number of markets. Economic data released since the previous FOMC don’t warrant a change in policy. If any, the risk is for some comments on risk-taking after all, but it is a low probability. Regarding the eco data, the payrolls and the ISM on Friday are the main releases. A decent payrolls report (225K) and a limited increase in the ISM are expected. Both suggest that the economy is doing well at the start of Q3. Q2 GDP will be released on Wednesday. Markets expect a 2.9% rebound, offsetting a similar decline in Q1. Friday’s durables figures, suggest that business investment may fall short of expectations, which means there are some downside risks to Q2 GDP. In EMU, attention will be on inflation data. On Wednesday, the German CPI measure and on Thursday, the EMU measure will tell us whether inflation has effectively stabilized at 0.5% Y/Y (euro measure). Belgian and Spanish Q2 GDP on Wednesday will give us a foretaste for the development of growth in the euro area during Q2.

Rating agency S&P affirmed the Belgian AA rating (stable outlook). The rating reflects S&P’s view of the high level of prosperity, the strong net external asset position and a relatively strong institutional effectiveness despite sporadic political stalemates. The strengths are moderated by a high government debt ratio and tax burden (limited fiscal flexibility). There should be no effect on the OLO market. Moody’s raised the Portuguese Ba2-rating by one notch to Ba1 (stable outlook), but remains junk at the big three rating companies. Two key factors led to that decision. First, Moody’s expectation that fiscal consolidation will remain on track despite unfavourable rulings by Portugal’s Constitutional court. Second, the government’s comfortable liquidity position with regained access to the public debt markets and sizeable cash buffers. The rating upgrade is a positive for Portuguese bonds and could lead to some outperformance, especially following the BES-mini-crisis.

In the US, the treasury starts its end-of-month refinancing operation with a $29B 2-yr Note auction. Currently, the WI is trading around 0.53%. Tomorrow a $35B 5-yr Note auction is scheduled and on Wednesday, the treasury concludes with a $29B 7-yr Note auction. EMU bond auctions are few with only Italian BTP auctions (Wednesday).

Overnight, Asian equity markets show again a mixed picture. China outperforms on comforting comments by Premier Li Keqiang.

Today, the eco calendar is very thin with only second tier US eco data. Later this week, that changes with the FOMC meeting, EMU inflation numbers and US Q2 GDP & payrolls. Ahead of these releases, we might get uneventful trading starting today. Wildcards are of course geopolitically related (Gaza-strip, Eastern Ukraine and Norwegian terror threat). Technical factors (Bund close to high, German 10-yr yield close to record low) might come at play as well.

Last week, we suggested that investors might have underestimated the signal of the better EMU PMI’s and that it may turn out to be of greater interest for core bonds; in the sense that it may signal a bottoming out of the 6 month downtrend in yields. However, there is not enough evidence yet to base a long term view on. Nevertheless, in a first instance, we changed our view to a sell-on up-ticks, preferably near the highs.