More bear steepening

Rates

Global core bonds took up where they left off the day before and immediately turned south again. Regional EMU services PMI’s printed very strong which was eventually confirmed by an upward revision of the EMU figure. For the first time in five days, the violent sell-off stalled during European trading. Some exhaustion kicked in with core bonds in heavily oversold conditions. The early losses were undone and sideways trading kicked in. A weaker than expected US ADP employment couldn’t trigger gains for core bonds, suggesting the sell-off is ripe for a pause but not yet for return action.

During the US trading session, core bonds came again under downward pressure. Fed chair Yellen said that bond yields could see a sharp jump when the Fed begins to raise rates. She also suggested that equity-market valuations are quite high and raised concerns that debt-market investors are taking excessive risks. Towards the end of trading, Atlanta Fed Lockhart (centrist) said all meetings were on the table for a lift-off (including June), but he believed that market expectations of a September rate hike were “reasonable”.

At the end of the day, the German yield curve bear steepened again with yields 0.2 bps (2-yr) to 13.8 bps (30-yr) higher. The US yield curve shifted in similar fashion with yields 1.2 bps (2-yr) to 8.1 bps (30-yr) higher. On intra-EMU bond markets, 10-yr yield spreads versus Germany widened up to 12 bps (Ireland).

Thin eco calendar

The eco calendar is somewhat lighter today with only French industrial production data and US jobless claims. The Norwegian central bank decides on rates, ECB’s Mersch is scheduled to speak and Spain (Bono & Obligacion), France (OAT) and Sweden (IL Bonds) tap the market. In the UK, attention goes out to the general elections.

After a stabilization in February, French industrial production is expected to have increased slightly in March, supported by stronger activity in the manufacturing sector. In the US, initial jobless claims are forecast to have picked up after having reached a multi-year low in the previous week. The consensus is looking for a pick-up from 262 000 to 279 000. We believe that the risks are for a lower outcome as the distortions due to the Easter holidays should have faded, which might keep the claims somewhat lower than in the weeks before.

Spain and France tap markets

The Spanish treasury auctions the on the run 3-yr (0.5% Oct2017) and 10-yr (1.6% Apr2025) Obligacion, as well as an inflation-linked bond for up to €5B. The Apr2025 bond cheapened significantly in ASW-spread terms over the past days and it will be interesting to see whether investors already see this as an opportunity or whether they hold a hesitant stance and wait to see how the current correction plays out. On the Spanish curve, the Apr2025 remains nevertheless rich. The French debt agency taps the on the run 10-yr OAT (0.5% May2025) and two off the run OAT’s (4.25% Oct2023 & 2.75% Oct2027) for a total amount of €7.5-8.5B. The OAT’s cheapened in ASW spread terms as well going into the auction. French auctions tend to go well and we don’t expect difficulties this time either.

Today’s Strategy

Overnight, Asian stock markets trade lower with Japan returning from Golden Week holidays. Yellen’s warning on rich stock markets weighs on sentiment. The US Note future trades sideways around the lows. The ECB lifted the Greek ELA-ceiling without raising the haircut on collateral. They ward off that discussion until after the May 11 Euro group meeting.

Today’s eco calendar is empty apart from US weekly claims. Yesterday’s trading (see above) suggests that sentiment on the Bund market remains bearish despite heavily oversold conditions. While the sell-off could pause, there’s no real case for return action at this stage (could change after payrolls). In yield terms, we think the correction only faces real resistance around 0.80% (38% retracement of move since early January 2014; currently 0.58%). Greece is a factor of uncertainty which weighs on peripheral bond markets but is ignored by the Bund. Higher core bond yields are also a drag on the periphery.

In the US, sentiment is negative for the US Note future. Weaker data are easily shrugged off (eg manufacturing ISM, trade balance, ADP) while better outcomes trigger a new sell-off (non-manufacturing ISM). We don’t expect a change before the release of the payrolls. Technically, the move below 128-04+ in the US Note future opens the path to 125-29+. Fed’s Yellen warned of a rapid rise in rates once the Fed starts hiking while suggesting that valuations on bond and equity markets are rich.