Horrible payrolls lift US Treasuries, but off highs at close

Rates

Global core bonds broke through the upper bound of established trading ranges following a disastrous US payrolls report. Equities were initially hit sharply, but managed to erase intra-day losses and even ended with juicy gains by closure time. Volumes were light for such a surprising payrolls report, suggesting that the argument of low yields for longer captured the imagination of fast money. Let’s see whether in the next days, real money investors join the optimism and lay a bottom under US equities (in a technical sense).

US Treasuries initially jumped higher, but couldn’t hold on to these juicy gains and struggled when equities rebounded. Positioning for upcoming supply was an additional negative. Contrary to equities, volume in the US Treasury Note future was high. US Treasuries outperformed German Bunds, except for the very long end. The US curve bull steepened with 2-5-yr yields 6.5 to 7 bps lower, the 10 and 30-yr yields were down by 4.3 and 2.2 bps respectively. The Germane curve bull flattened with yields 0.2 bps to 4.4 bps lower. The main resistance at 129-10+ is not yet decisively broken and neither is the US 10-year yield (1.994%.

The September payrolls were at 142K way below consensus and against all predictions, the August payrolls weren’t revised higher, but instead lower to 216K. Other indications like flat AHE, slightly shortened workweek and a drop in the participation rate all came out on the same wrong side. Coupled with a weak ISM manufacturing, released Thursday, barely above the 50 boom bust line, it seriously questions whether the Fed will be able to lift off its rates this year. The odds are now less than even of that happening. Admittedly, the Fed was still largely in favour of a 2015 lift-off, but last week’s eco data together with potentially political upheaval around the 2015/16 budget, a government shutdown and debt ceiling issues, the odds are now against a lift-off in 2015. Of course, August/September payrolls may be outliers, but it will take time for the Fed to have sufficient evidence that that’s the case. Boston Fed Rosengren said that the lift-off is likely to happen soon. Raising rates in 2015 remains a reasonable forecast if growth is 2-2.5%. Given that Rosengren is normally a dovish governor, these comments are rather hawkish, but after the payrolls he said the Fed was right to delay a lift-off decision in September. Similarly, Fed Bullard, a hawk, repeats his bias to start normalizing rates and downplays the payrolls report. We wait now for more Fed comments.

All eyes on US manufacturing ISM

Today, the US Non-manufacturing ISM will draw all attention following the very weak payrolls published on Friday. In EMU, the final services PMI will get less attention as will the outdated retail sales, but in the UK the services PMI (first reading) might help colour morning trading: a slight rise to a respectable 56 is expected (we agree). The September US Non-manufacturing ISM is expected to drop 57.5 in September, previously 59. While the second drop in a row, the level is still very high and if confirmed would point to still strong domestic demand and ease fears of a growth slowdown following the release of the manufacturing ISM and the payrolls. A bigger than expected drop would only exacerbate fears for a more pronounced slowdown. We don’t exclude such a setback, as the index jumped in July sharply higher, on which there may now be a more outspoken pullback.

Portuguese election; Spanish upgrade

Portuguese PM Passos Coelho’s center-right coalition won the general elections, but they lost their parliamentary majority. They retain 104 seats in the 230-seats Portuguese parliament against 85 seats for the centre-left Socialist party. The Socialists admitted defeat and ruled out a coalition with extreme leftist (anti-EU) parties which gained a combined 36 seats. Passos Coelho already said that he would inform the Portuguese president that he was available to form a minority government. The ruling coalition and the Socialist party share a common commitment to remain in the euro and meet fiscal targets agreed with the EU. Therefore, the minority government nevertheless has a decent chance of survival. Passos Coelho is the first PM to be re-elected after a harsh austerity programme. On Portuguese bond markets, we expect little impact as the election victory was in line with expectations and is thus likely discounted in bond prices.

Rating agency S&P upgraded the Spanish rating by one notch (BBB to BBB+; stable outlook). Spain is rated Baa2 (positive outlook) at Moody’s and BBB+ (stable) at Fitch. The upgrade reflects S&P’s view of Spain’s strong, balanced economic performance over the past four years, which is gradually benefiting public finances. The rating action wasn’t expected as the outlook on the Spanish rating was stable and general elections are held later this year. Therefore, we expect outperformance of Spanish bonds today.

Today: 2015 lift-off expectations completely dashed?

Overnight, Asian stocks markets trade around 1.5% higher in line with WS’s comeback following the weak payrolls report. The US Note future trades marginally higher though. Today’s key release is the US non-manufacturing ISM. Risks are on the downside of expectations. In combination with disappointing US manufacturing ISM and payrolls last week, this could further push back lift-off expectations (2016). That’s a positive for the US Note future and force a test of the post-payrolls high (130-00+). After the dovish September FOMC meeting, we eyed a return to the contract high (129-10+), but we didn’t anticipate a break higher. That last assumption is now under severe pressure. Therefore, we hold off setting up short positions until the dust has settled. Fed members confirming that a 2015 lift-off remains the preferred scenario is a possible trigger. Fed George (Tuesday), Williams, Bullard (Wednesday), Kocherlakota (Thursday), Lockhart and Evans (Friday) are scheduled to speak. For the Bund, the reasoning is similar. A break of the 10-yr yield below 0.47% would make the technical picture bullish. The EMU calendar is uninspiring today.

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