The German Bund tested Friday's lows

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Yesterday, global core bonds consolidated higher in a low-volume eventless trading session. The German Bund tested Friday’s lows (important support 147.77/92) at the start of the trading, but the test failed and the Bund consolidated higher. Ahead of the Fed, a break is unlikely. During the US trading session, US eco data were mixed. The market reaction on both data was however similar: core bonds drifted cautiously higher, but soon bonds slid into a tight sideways range. The explanation of the price action is straight forward.
Last week, hawkish FOMC expectations drove a significant bear steepening of the US yield curve. With the Fed decision coming closer, some consolidation was always likely. The belly outperformed the wings, but especially the 30-yr whose yield was unchanged. 5-yr yields outperformed, as they fell 3 bps. The German yield curve traded 1 bp (2-yr) to 1.7 bps (10-yr) lower. On intra-EMU bond markets, 10-yr yield spread changes versus Germany ranged between flat and +4 bps (Ireland).

Today, the eco calendar remains only moderately interesting with the German ZEW indicator and US PPI inflation data. The Fed will start its two-day FOMC meeting and ECB’s Liikanen is scheduled to speak. Slovakia (Bonds) will tap the market. The ECB holds its weekly MRO tender, ahead of Thursday’s TLTRO. The German ZEW indicator has weakened for already eight consecutive months and is now more than 50 points below its peak reached in December 2013. For September, the consensus is looking for a further, albeit limited drop from 8.6 to 5.0. We believe that the risks might be for an upward surprise after the ECB’s new measures and as geopolitical tensions eased slightly. In the US, PPI inflation is expected to come out flat on a monthly basis, while the annual reading is forecast to have picked up from 1.7% Y/Y to 1.8% Y/Y. Lower energy prices will probably weigh on the headline reading, while most other commodity prices declined too, which will probably be (partly?) offset by higher prices in the services sector. As a result, there are risks for a downward surprise.

Later this week, event risks will prime. The FOMC meets on Tuesday/Wednesday. Besides the announcement, the FOMC rate projections and the press conference will make it very interesting. Will the Fed adapt its forward guidance? (Preview flash will follow) The Scottish referendum on independence takes place on Thursday and a yes vote could create a lot of volatility, also outside the sterling markets. Finally, the ECB announces the results of its first ECB TLTRO tender. A limited take-up would raise doubts on the success of the ECB’s strategy to fight deflation risks. Finally, the US eco calendar is attractive too, but may be overshadowed by these events.

In France, the government faces a confidence vote as PM Valls presents his policy to the National Assembly. The government is expected to survive the vote but the narrowness of the lead will be a sign of its fragility. On Thursday, President Hollande holds a press conference. He will explain economic policies and the country’s fiscal slippage. Given his 13% approval rating, he can grab the opportunity as well to crack up his popularity. Finally, Moody’s will update the French rating on Friday. Currently, France is rated Aa1 with a negative outlook. Given weak growth and last week’s announcement by FM Sapin that the government delayed reaching a 3% budget deficit to 2017, risks are for negative action. Given this French “event” calendar, some underperformance of French bonds is likely this week.

Overnight, most Asian equity markets trade with small a negative bias. Japanese markets return from the long weekend. Overnight, the US Note future has a modest upward bias. The Bund should open modestly higher.

The eco calendar is thin with German ZEW (risks on the upside) and US PPI (risks on the downside). We don’t think that eco data will be relevant for markets as the 2-day FOMC meeting starts today. Last week, hawkish FOMC expectations (Fed dots & forward guidance) drove a significant bear steepening of the US yield curve. The German curve copied the move, both because of the ECB’s QE announcement and the developments in the US.
For today, we hold on to the consolidation bias. Uncertainty on Scotland helps a safe haven bid. Only if the Fed lives up to hawkish expectations, the bear steepening can resume.

Technically, the US Note future broke below the neckline of a double top last week. Targets stand at 123-23+ and 123-10. In yield terms, the US 10-yr yield moved back in the broad 2.5%/3% range with a test of 2.61%/2.66% zone ongoing. For a break higher, a hawkish Fed will be needed. For the German Bund, the bull run seemed to have taken a pause. First support is under pressure (147.92) with the German 10-yr yield approaching 1.12% resistance. Believe in the ECB’s QE and a ripple-effect from the US should be able to force a break. But again ahead of the FOMC (and 1st TLTRO), consolidation is likely.