The US/German 10‐yr yield spread rose to the highest level

Rates

Yesterday, German Bunds had a strong run and outperformed US Treasuries on the back of dovish comments of ECB president Draghi (late Friday) and weak IFO business sentiment. Stronger equities were unable to dent the bull run (as the same dovish Draghi comments were the main driver for equities too). The US/German 10‐yr yield spread rose to the highest level since the creation of the euro (146 bps). Yields at the German yield curve are now again negative up to the 3‐yr sector. German 5‐ and 10‐yr yields dropped to historical lows at respectively 0.16% and 0.92% (intraday). Peripheral bonds still outperformed (on Draghi) and 10‐yr yield spreads fell 6 (Italy), 9 (Spain) and 17 bps (Portugal). Bloomberg reported that Italian, Spanish and Austrian 10‐yr yields fell to the lowest levels since they started collecting data. In the US Treasury market, the price action was less straightforward, which is no big surprise, given the debate on the normalisation of monetary policy. This resulted in the continuation of the flattening of the curve. The longer end profited from the overall reach for yield with 10‐ and 30‐yr yields down 2‐2.5 bps, while the 2‐ and 5‐yr yields were marginally higher (less than 1 bps). One small note of caution, traded volumes were thin with UK markets closed for Summer bank holiday.

In a nutshell, ECB Draghi’s specifically mentioned in a speech at Jackson Hole the decline of the 5yr/5yr inflation swap (below 2%), a key gauge for defining medium term inflation expectations in the context of risks to price stability (“Governing Council acknowledges these developments”). Regarding monetary policy, he added that the central bank stands ready to adjust policy further (ie ECB QE?) if necessary. This strongly suggests that more easing is on its way. Apart from monetary policy, Draghi also said that fiscal policy could play a greater role to boost aggregate demand. He mentioned the “overall fiscal stance of the euro area”, hinting at more fiscal coordination.

Today, the euro zone eco calendar is empty. In the US, the Conference Board’s consumer confidence reached a new multi‐year high in July, rising above the 90‐ level for the first time since 2007. For August, the consensus is looking for a modest correction from 90.9 to 88.5. Despite firm data recently, the risks are for a downward surprise as geopolitical tensions might weigh on sentiment. Regarding business sentiment, the Richmond Fed index is forecast to show a limited drop in August following an improvement in July. The headline index is expected to drop from 7 to 6, but we believe that a stronger reading is not excluded. The index points to moderate growth, in contrast to several other indicators which are at stronger levels. Earlier released indicators for August showed a mixed picture. Finally, durable goods orders are forecast to show a strong rebound in July spurred by a surge in Boeing orders. We prefer to look at the ex‐transport reading which is forecast to rise by 0.5% M/M following a 1.9% M/M jump in June. We side with the consensus.

Today, the US treasury starts its end‐of‐month refinancing operation with a $29B 2‐yr Note auction. Currently, the WI is trading around 0.52%. Later this week, the Treasury continues with a $35B 5‐yr Note auction, a $13B 2‐yr floating rate Note auction and a $29B 7‐yr Note auction. In EMU, this week’s issuance calendar is thin with only Italy tapping the market. Today, they sell up to €3.5B zero‐coupon bonds (CTZ). On Thursday, the debt agency launches a new 10‐yr BTP (€3.5‐4B 2.5% Dec2024) and taps the 5‐yr BTP (€2‐2.5B 1.5% Aug2019) and a floating rate CCTeu. Finally, a Reuters article suggested that Greece plans to reopen its 3‐yr (3.375% Jul2017) and 5‐yr bond (4.75% Apr2019) issues in the next two weeks to top them up by up to €1.5B. Earlier this year, Greece returned to the international bond markets after 4‐yr absence with two syndicated deals. This week’s auctions won’t be supported by redemptions.

Overnight, the Draghi inspired rally on equity markets got no follow‐up in Asia. Japanese stocks underperform on the back of a firmer Japanese yen. The US Note future however still trades with an upward bias despite the thin news flow and this week’s upcoming US supply.

Today, the eco calendar is extremely thin with only US eco data of importance (see higher). We see risks for some opposite surprises versus consensus, which should keep market reaction limited. The meeting between Russian president Putin and his Ukrainian counterpart Poroshenko is a wildcard though German Chanceller Markel indicated that the talks probably won’t end the conflict. US supply is a marginally negative factor for US Treasuries. London traders return from a long weekend which probably means we’ll see volumes rising.

The Jackson Hole meeting made it clear over the weekend that the likelihood of ECB QE increases. This boosted bonds further with another low for the German 10‐yr yield (<0.95%). While we don’t prefer to buy Bunds at such lofty levels, the uptrend (in priceterms) remains intact. Technically, the Bund is again in overbought conditions.