US eco data and German IFO focal points

Rates

Core bonds don’t really profit from risk off sentiment

Global core bonds ended the session slightly lower (German bonds) to moderately higher (US Treasuries) despite wild panic trading in equity, commodity and FX markets. Traded volumes were very high. US equities lost between 3.5% and 4%, but were off the session lows. The dollar was hammered and so were most commodities and emerging markets. The all in all lukewarm reaction of the safe haven bonds suggests that investors didn’t fundamentally change their view on the upcoming Fed tightening cycle. A second explanation for the “tepid” bond reaction might be forced selling, also of bonds, as capital guaranteed funds turn to cash. The rate sensitive 5-yr US Treasury outperformed. The German yield changes were very modest (up to 2.8 bps higher on the 10-yr) The peripheral bonds were barely affected by the risk off. 10-yr yield spreads widened up to 3 bps. So, until now peripheral bonds are immune for the risk off sentiment.

There were no specific new events or data releases yesterday. It is still the same theme that haunts investors. The clumsy policy reaction of the Chinese authorities on the Chinese equity market and its devaluation of the yuan suggest that the Chinese economy and by extension maybe the global conditions are in a worse than many expected shape. The transition of the Chinese economy from an industrial towards a service oriented one clearly doesn’t occur without hiccups. Obviously the Chinese problems affect commodity and emerging and FX markets. A second issue is fear for a nearby US Fed rate hike that only exacerbate fears for a slowing world economy and deflation.

US eco data and German IFO focal points

In July, US Conference Board’s consumer confidence weakened sharply, falling from 99.76 to 90.91. For August, the consensus is looking for a limited improvement, from 90.9 to 93.4. We believe that the risks are for an upward surprise, due to strong US labour and housing market data and lower oil prices.
Also US new home sales are expected to have rebounded in July following two monthly declines. The consensus is looking for a rebound by 5.8% M/M to 510 000. Favourable weather conditions and low mortgage rates support sales, although low inventories are an issue. Risks remain for an upward surprise. Over the previous three months, the Richmond Fed index has made an impressive rebound, rising from -1 in April to 13 in July. For August however, the consensus is looking for a limited decline to 10. Slowing demand from abroad might weigh on the index. Earlier released regional indicators showed a mixed picture. We have no reasons to distance ourselves from the consensus. Finally, in Germany, the IFO business climate indicator is expected to have weakened again in August, from 108.0 to 107.6, following a limited improvement in July. Last week’s German PMI came out surprisingly strong, despite heightened uncertainty around China and worsening sentiment on financial markets. It will be interesting to see whether the IFO shows a similar pattern. Due to worsening sentiment on financial markets, risks are for a downward surprise.

Today: Focus remains on equity/commodity markets

Overnight, Chinese stock markets suffered another 6+% blow and are now dragging other Asian bourses lower too (they traded higher earlier). . The US Note future trades modestly lower, but erases losses going into the start of European dealings.

Today, the eco calendar contains German Ifo (downside risks), US consumer confidence, Richmond Fed Index and new home sales. Risks to US eco data are on the upside of expectations, but risk being overshadowed by global turmoil. The global equity rout supported global core bonds (especially US Treasuries) over the past trading week. Lower oil/commodity prices are positive as well (EMU 5y5y inflation expectations fell to 6-month low; the US gauge to the lowest level since 2009). However, given the magnitude of the oil/stock market crash, the Bund and US Note future profited only marginally from safe haven flows. On peripheral bond markets, the increased volatility didn’t trigger huge spread widening.
Nevertheless, given current sentiment we wouldn’t fight the “logical” trends. A further commodity & equity correction/increase in volatility should be positive for core bonds and negative for peripheral ones. Recent events pushed market expectations of a first Fed rate hike into 2016. We don’t rule out a September lift-off yet though, if global markets stabilize the next few days.

Technically, the Bund reached its highest level since early May with the German 10-yr yield below the 50% retracement level of the spring sell-off.
Key support stands at 0.47% (June low) to 0.43% (62% retracement). While yesterday’s trading session showed a bearish engulfing pattern, it isn’t necessarily a trend reversal. We wouldn’t short the Bund at this stage already. The US Note future set a new contract high (129-28+) with the US 10-yr yield temporary below 2%. Next important support at 1.82%.