US payrolls of crucial importance

Next report will be published on 12th July, 2017

Rates

Law of gravity pulls Bund through major support

In past sessions, the Bund reached the key 161.68/58 support (neckline double top/38% retracement), but couldn’t rebound sustainably. Every attempt to move away was aborted, suggesting buyers’ fatigue. Yesterday, that was no longer the case. In a morning session devoid of key economic releases, the Bund future dropped below the key support, immediately attracting more selling that would last with a close at the day lows with a loss of about 130 ticks. There is no obvious trigger available to explain the break. News agencies attribute it to a “weak” French (and Spanish) auction of long papers, but we don’t buy in it after examining the results. ECB Villeroy said that “ECB’s non-standard monetary stimulus will not last indefinitely” and added that “nominal interest rates, which are still particularly low today, have started to rise since autumn 2016 and are set to increase further, in line with the pace of economic recovery and inflation growth”. However, these remarks were in the market well ahead of the break at 11h. We think that the Draghi’s speech last week and the BIS warning on too accommodative monetary policy fertilized the soil for today’s move and comments of Villeroy at best were considered as confirmation that the monetary normalisation process is about to start in the next months. In this respect, while we fully embrace the importance of the technical break and the re-positioning it may cause, we still like a confirmation and a weekly close above the 0.50% yield resistance and the 161.68/58 Bund support. The US payrolls today (and the market reaction) will show us whether the break is indeed a defining moment for the European bond market. Peripheral yield spreads were barely affected with Ireland, Portugal and Greece even showing some (very) modest narrowing.

US Treasuries (and gilts) followed Bunds lower. The ADP report was weaker than expected and the initial claims marginally higher than expected, but at best this allowed US Treasuries to trade sideways again. A strong non-manufacturing ISM pushed the US Treasuries back to intra-day lows, but ahead of the payrolls there was no stamina to push it below. Some short covering limited the daily losses.

In a daily perspective, German yields increased by 2.2 (2-yr) to 9.2 bps (10-yr), the belly underperforming the wings. The key 0.50% yield resistance for the 10-year Bund was broken and similarly, the 5-yr Bund yield confirmed the break of the -0.26% and is now closing in (helped by benchmark change) on the psychological 0% yield resistance. The US yield curve bear steepened with yields varying from -0.8 bp (2-yr) to +5.5 bps (30-yr), limited the losses ahead of the payrolls release.

US payrolls of crucial importance

The June payrolls will be of the utmost importance and will overshadow all other releases. The market expects a decent 177K job gain following a weak 138K in May, 174K in April and a dismal 50K in March. The ADP employment report showed increases in past months stronger, but was weaker in June with 158K instead of the expected 188K gain. We believe that the risks for the payrolls are on the upside of expectations as the three previous months looked to be unusually low.. The unemployment rate could stabilised or even tick up after a (too fast?) decline in past months. The AHE wages are expected to be up 0.3% M/M. We have no strong take on the wages, but a disappointment might colour the market reaction.

US Payrolls to dominate trading.

Overnight, Asian equities limit the losses compared to WS losses yesterday. The T-Note future trades with a negative bias, even as losses are contained. We are curious to see how, after an exhaustion-like selling spree yesterday, the Bund will move ahead of the payrolls. Anyway, it will be the payrolls that decide if the technical break is confirmed (favoured).

Regarding bond trading today, we see upside risks for the June US payrolls count. After the stronger survey evidence of this week, the payrolls could strengthen the belief that US economic growth is reaccelerating again after a period of more sluggish growth figures. This could give the Fed the opportunity to normalize its policy according to plan. We are not convinced that the strength of the headline figure will also be reflected in the wages and unemployment rate. Regarding the T-Note future, we identify 124-12/01+ are a key support (neckline double top/62% retracement), of similar key value as the Bund support that was broken yesterday. In case of a strong report, the support might come into play. However, the distance is likely still a tad too far to break on a first attempt. In case of a weak report, we will look to see if the Bund can stay below previous support (now resistance) at 161.68/58. Next support at 160.17 (within reach). If broken, this could point to a full retracement towards 158.89.

We hold our sell-on-upticks strategy as markets reposition for a new stage in the global monetary cycle: policy normalisation. The peak of central bank dovishness is behind us. In case of a strong report we might also see a negative reaction on the short end of the US curve and a further steepening of the German curve.

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