US concludes end-of-month refinancing operation

Rates

Disarray in bond land, as Draghi prepares policy turn

ECB president Draghi surprised traders and investors yesterday as he explained how the ECB could gradually unwind its non-conventional stimulus measures. It was clearly a turnaround of the ECB president, who sounded optimistic on growth, even if he remained very cautious and suggested that policy changes should be very gradually and depending on improving dynamics in the economy. "As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments -- not in order to tighten the policy stance, but to keep it broadly unchanged." Mario Draghi repeated that the governing council needs to be patient in letting inflation pressures build, but his remarks should nevertheless be considered as an early signal that policy will be adapted with a formal announcement of tapering likely at the September meeting. Of course, the economy and inflation should evolve as expected. Other news went to the background and didn't impact trading. US consumer confidence and Richmond Fed manufacturing were strong and stronger than expected. Philly Fed Harker repeated his previous comments. Chairwoman Yellen covered a lot of issues, but didn't come back on her post FOMC comments. The US 5-year Note auction was a little weak.

The Bund was relentlessly sold from Draghi's comments into the close and ultimately shed a massive 189 ticks to 163.26, painting a bearish double top on the chart amid high volumes. The US Note future followed the Bund lower, but limited the daily losses to 16/32. It touched the previous low, but a break didn't occur.. In a daily perspective, German yields increased 5.9 bps (2-yr) to 12.5 bps (10-yr), while US yields added 3.7 bps (2-yr) to 6.8 bps (10-yr). On the intra-EMU bond markets, yield spreads versus Germany were small Italy that underperforming (+4 bps) ahead of supply and Greece outperforming (-6 bps).

Thin calendar

The eco calendar contains mostly second tier releases with little market moving potential. That's the case for June French consumer confidence (upward risk in the wake of the elections?), Italian June HICP (suggesting another month of declining headline inflation?),US wholesale inventories (neutral) and US pending home sales (rebound following back-to-back declines in March/April?). The trade balance deficit is expected to have fallen slightly in May, but the Q2 trade deficit will nevertheless surpass Q1 deficit, suggesting a negative contribution to Q2 GDP. EMU M3 money supply data should show ongoing expansion of M3 around 5% and a slow recovery of the bank lending.

US concludes end-of-month refinancing operation

The US Treasury continued its end-of-month refinancing operation with a soft $34B 5-yr Note auction. The auction stopped with a moderate tail and the bid cover (2.33) was the lowest since February. Bidding details showed decent indirect and direct bids, but a disappointing dealer bid. The US Treasury ends its refinancing operation tonight with a $13B 2-yr FRN auction and a $28B 7-yr Note auction. The WI of the latter trades currently around 2.045%.

Draghi steps up to the plate

Most Asian stock markets lose marginally ground overnight with China underperforming (-0.5%). Losses remain modest given WS's correction lower (Nasdaq underperforming; -1.5%). Brent crude extends its modest correction higher, while the US Note future trades with a small downward bias. We expect a neutral opening for the Bund.

Today's eco calendar only contains second tier US eco data while Fed Williams already spoke recently. Markets will further digest ECB president Draghi's comments. Can "deflationary replaced by reflationary forces" become the new "whatever it takes"? We recommend a sell-on-upticks strategy in the Bund with markets further positioning towards the next step in the ECB's normalisation process (unwinding asset purchases). Technically, the German 2-yr yield broke above important resistance (-0.63%/-0.60%), painting a multiple bottom formation on the charts. On EMU bond markets, it could mark an end to the long-term narrowing trend. US yields rose to a lesser extent yesterday, but the 10-yr yield followed the 5-yr yield and settles back above key support. We also support a sell-on-upticks strategy in US Treasuries as markets are too dovish positioned given the Fed's future tightening intentions.

The (US) equity market correction and Trump's legislative problems could play an impeding role in our strategy short term.

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