Tentative trade truce and Brexit progress weigh on bonds

Global core bonds sold off last Friday as white smoke emerged both from Brexit and from US-Sino trade talks. The first selling wave originated in the UK Gilt market after key political actors confirmed Thursday’s progress made by UK PM Johnson and Irish PM Varadkar, taking negotiations to a higher level. General risk sentiment flared and turned even more upbeat after Washington trade talks resulted in a partial trade accord, yet to be put on paper, on IP, financial services and agriculture. US Treasury Mnuchin added that planned tariff increases won’t be implemented this week. US Treasuries underperformed German Bunds towards the end of dealings. US yields rose by 3.3 bps (30-yr) to 6.6 bps (5-yr) on a daily basis. The German yield curve steepened with yield differences ranging between -0.9 bps (2-yr) and +5.1 bps (30-yr). 10-yr yield spread changes vs Germany narrowed by up to 4 bps with Ireland (-7 bps) outperforming. The US Fed also announced around the European close a more permanent fix to control the level of the federal funds rate and other short-term interest rates. The Fed will purchase Treasury bills at least into the second quarter of next year in order to maintain over time ample reserve balances at or above the level that prevailed in early September 2019. The initial pace will be $60bn/month. In addition, it will extend overnight repo operations (at least $75bn/operation) at least through January of next year while also offering multiday repos of at least $35bn/month, generally twice a week. Asian stock markets trade positive with China and South Korea (>1%) outperforming and Japan closed for Health-Sports Day. The move is mainly a catching up one with Europe and WS last Friday. Core bonds are positively oriented this morning. Dismal September Chinese trade data and the EU pouring cold water over Johnson’s Brexit proposal both dampen Friday’s party mood. Today’s eco calendar only contains outdated EMU industrial production figures. Most US markets are closed for Columbus Day. The tentative trade truce will be overshadowed by Brexit talks in the run-up to this week’s EU Summit. Friday’s optimism – which nevertheless ended on a sour note for US stock indices – will be tested. Without additional news, we think the German 10-yr yield will run into resistance. US trade volumes will be extremely low.

Technically, the German 10-yr yield and US 10-yr yield both rebounded away from August lows following ECB/Fed September policy meetings. Both fell short of really testing first resistance levels, respectively at -0.41% and 1.94% as disappointing eco data ended the run. Bullish risk sentiment now causes a return to the upper bounds. Going forward, we expect range trading with August lows protecting the downside (German 10y: -0.73%; US 10y: 1.43%).

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