Key technical break German 10-yr yield

Rates

Global core bonds eked out additional gains on the back of more global monetary policy easing (BoJ). Bonds ignored the risk-on sentiment that pushed equities and to lesser extent oil (and commodities) higher. The Bund extended gains throughout European dealings despite overbought conditions and even added some extra gains during early US dealings. The German 10-yr yield dropped further below the 0.42% support zone. This technical break is highly relevant and suggests a complete retracement towards 0.05% (all-time low).
Headline EMU inflation increased as expected to 0.4% Y/Y, but core inflation was a tad above expectations at 1.0% Y/Y. US GDP Q4 GDP was close to consensus at 0.7% Q/Qa, as was the ECI (Employment Cost Index), while Michigan consumer sentiment was a bit weaker and the Chicago PMI a lot strong than expected. It didn’t affect bonds much though. In a daily perspective, the German yield curve bull flattened with yields 3.8 bps (2-yr) to 8 bps (30-yr) lower. Both the 2-yr and 5-yr yield reached new all-time lows (respectively -0.49% and -0.31%). Changes on the US yield curve varied between -4.3 bps (2-yr) and -7.1 bps (5-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany narrowed up to 4 bps with Greece underperforming (+11 bps).

The BoJ was the latest central bank to make a dovish turn. Earlier, the BoE postponed its lift-off “sine die”, the ECB pre-announced a March easing package and the Fed sounded doubtful on the outlook/rate path. The new monetary policy shift supports core bonds. Riskier assets might keep up (eg Friday) or gain further ground as long as the credibility of the central banks holds. We think that with each new measure the impact may diminish, especially as they are unable to reach their objective of higher inflation. The BOJ move clearly strengthened the case for March ECB easing, as it strengthened the euro (4% on trade weighted basis since early December). However, if the market start seeing the policy moves as “currency war”, it may lose confidence. We will closely listen to what central bankers will say.

Focus on manufacturing business confidence

The preliminary January euro zone manufacturing PMI showed a decline from 53.2 to 52.3, below the consensus of 53.0. The final reading is forecast to confirm this outcome. National data showed a slowdown in both Germany and France. The details however were not too bad. Nevertheless, we continue to see downside risks following a weaker IFO and EC’s confidence indicators. In the US, regional indicators were mixed, but the manufacturing ISM is expected to show a limited improvement from 48.2 to 48.5. For the US, we are a little more optimistic as orders and production picked up slightly in December and also the Philly Fed index/ Markit PMI showed some improvement.

Relatively thin bond supply

This week’s supply comes from Germany, Spain and France. On Wednesday, the German Finanzagentur launches a new 5-yr Bobl (€5B 0% Apr2021). On Thursday, the French debt agency taps the on the run 10-yr OAT (1% Nov2025), the off the run 15-yr OAT (3.5% Apr2026) and the off the run 30-yr OAT (4% Oct2038) for a combined €7.5-8.5B. The Spanish Treasury taps the on the run 10-yr Obligacion (1.95% Apr2026) and off the run 30-yr Obligacion (4.2% Jan2037). The amount on offer still needs to be announced. The auctions will be supported by a €20.6B Obligacion redemption.

GE 10y yield below final support; heading to 0.05%?

Overnight, Asian equity markets can’t really build on Friday’s rally in the US. Japan outperforms (+2%; in the wake of Friday’s BoJ easing) while China underperforms (-2%; mixed PMI’s). Fed governors Kaplan and Williams commented on monetary policy. Kaplan needed time to judge the impact of recent market turmoil while Williams sees a slightly slower tightening pace.
The US Note future trades stable suggesting a neutral opening for the Bund.

Today’s eco calendar is interesting with final EMU PMI’s and US Manufacturing ISM. Risks for the EMU are on the downside, risks for the US on the upside. Given that the former is a revision, we attach most attention to the US gauge. In combination with overbought conditions (both Bund and US Note future), a strong number could trigger some short term profit taking on this year’s impressive rally, making markets somewhat more neutrally positioned into Friday’s payrolls release. Vice-Fed Fischer’s speech after European trading is a wildcard, as is ECB Draghi’s one.

Overall sentiment remains positive on bond markets. The dovish turn of global central banks (ECB, BoE, BoJ and Fed) pulled yields lower. Technically, the German 10-yr yield fell below final support (0.42%). That opens the way for a complete retracement towards the all-time low at 0.05%. The US 10-yr yield dropped below the 2% mark, heading for a test of support around 1.9%.

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