The FOMC left the forward guidance unchanged

Rates

On Friday, core bonds eked out moderate gains, while especially the US curve flattened. Initial risk-on sentiment (Scottish No) faded and key support levels held upon test. The surprise insistence of the Catalonian PM to hold a referendum on independence (Nov 9) and a dangerous further decline of inflation expectations pushed core bonds higher in the afternoon. High weekly repayments of 3-year LTRO’s and dropping inflation expectations were additional positives as they raise the pressure on the ECB to come up with yet another asset purchase programme (of sovereign bonds). In a daily perspective, German yield declines remained modest though (up to about 3.9 basis points). US yields are up to 6.4 basis points lower (30-year) with the curve sharply flatter, as some short covering kicked in. Peripheral spread narrowing was partially reversed in the afternoon. There was no noticeable underperformance of Spain.

Today, the eco calendar contains the US existing home sales and the first estimate of European Commission’s consumer confidence for September. ECB’s Draghi & EU’s Barnier will speak before the EU Parliament and ECB’s Praet will participate in a panel discussion on the future of the global monetary system. On the supply front, Belgium will tap the market (OLO). (See below)

After a weakening in the second half of last year and early this year, US existing home sales picked up again over the previous months. Existing home sales rose already for four consecutive months and a further improvement is expected for August. The consensus is looking for a limited increase by 1.0% M/M to a total level of 5.20 million. We believe that the risks might be for another strong reading as inventories have picked up. European Commission’s consumer confidence is forecast to have weakened slightly further in September. The consensus is looking for a drop from -10 to -10.5, which if confirmed would be the fourth consecutive decline. We believe that the risks might be for a slightly stronger outcome as geopolitical tensions have eased somewhat recently.

Looking further ahead to the eco calendar, in EMU the Sept. PMI business surveys will be released on Tuesday, the German IFO business sentiment on Wednesday and the August M3 money supply on Thursday. Following the unexpectedly rapid decline in sentiment in past months, markets hope to see a pause in September. If the worsening of sentiment would have continued, core bond market should rally as it would increase deflation fears, given the recent low inflation and dangerous sliding of inflation expectations. Pressure on the ECB to do more would only mount. In the US, the eco calendar is a bit light. The initial claims and the durable orders on Thursday are the only potential movers.

Regarding supply, only the Belgian (today) and Italian Treasury (Thursday) will tap the market. The Belgian debt agency holds its regular monthly OLO auction The 10-yr benchmark 2.6% June 2024 & the 3% June 2034 are on offer for a targeted amount of €1.5-to-2B. The Belgian Treasury has already fulfilled 82% of its 2014 financing needs (€30B). It aims to raise still €5.5B at today’s and the last two auctions of the year. We expect the auction to go well. On Thursday, the Italian Treasury holds a BTPei/CTZ auction. The ECB’s MRO tender (tomorrow) will spark a lot of attention following last week’s first TLTRO and the big LTRO repayment. How big will excess liquidity be on settlement Wednesday?

Attention will also focus on Fed talk following last week’s FOMC meeting. The FOMC left the forward guidance unchanged, was soft on its assessment of the economy and inflation and thus looked not hasty to prepare markets for policy normalization. However, the rate projections were hawkish. Markets focused on the latter. So, it will be interesting whether Fed governors will try to “rectify” the initial bearish reaction on the bond markets. The Fed revue starts with NY Fed Dudley (dove) today, followed by several other further out this week.

Also the ECB will be under close market scrutiny. Despite the new measures announced in September, the ECB remains under pressure to do more. A disappointing low up-take at the first TLTRO and a big repayment of LTRO loans means that excessive liquidity and the ECB’s balance sheet will only increase modestly. Mr. Draghi’s hope that all recent measures together might boost its balance sheet by €1T seems now more a dream than a real possibility. Combined with dangerously sliding inflation expectations, the ECB is currently cornered. ECB President Draghi will speak before parliament today (15h) and; again in Vilnius on Thursday. Markets will closely listen to eventual comments on the TLTROs, the ABS/CB programme and on inflation expectations. Every comment on these might be market moving. In the weekend, both ECB’s Coeure and Visco said it is too early to judge if more easing is needed.

Overnight, Asian equities started the week on a weak footing (see headlines). Moody’s confirmed France’s Aa1 rating, but kept its negative outlook. It noted the gradual erosion of strength and expects the debt ratio to move > 100%. However, the size and wealth of the economy allowed it to confirm the rating. The IMF warned that low rates could result in excessive market risk. US Treasuries are higher and the Bund opens higher too.

Today’s market calendar is interesting. Eco releases could be a moderate negative (upside risks), but the eco data are likely not so important. Draghi and Dudley are more interesting. Draghi is cornered by recent developments. We expect him to play for time and cool the ever more aggressive market expectations (see comment Coeure/Visco). Dudley, as a dove, should be a positive for bonds, as is the risk-off sentiment. Last week, the US Treasury market tested intensive yield resistance (5-yr: 1.85%, 10-yr: 2.66/69%) but could break higher. This suggests that the down-move (prices) might be at least temporarily stopped. In this respect, we change our ST outlook to neutral from bearish for US Treasuries with a 123-10 to 125 ST trading range. For the Bund support stands at 147.92/63 and if the uptrendline at 148.70 (under test) is recaptured, the next key resistance is the contract high at 149.91.