Asian stock markets lose up to 5% overnight

Rates

US 10-yr yield tests important support

Core bonds eked out substantial gains yesterday, but it wasn't because of follow-up buying after Wednesday's evening FOMC meeting. The new upleg started in Europe following a batch of disappointing PMI's (2nd month in a row though still at lofty levels) and accelerated as stock markets heavily sold off in the run-up to US President Trump's tariff announcement against China. Main US indices closed up to 3% lower. The US yield curve bull flattened with yields 2.6 bps (2-yr) to 5.9 bps (10-yr) lower. German yields declined by 1.6 bps (2-yr) to 6.3 bps (10-yr). 10-yr yield spread changes vs Germany widened up to 2 bps with Portugal (+6 bps) and Greece (+14 bps) underperforming. S&P gives an update on the Spanish rating tonight (BBB+, pos. outlook). The limited impact of the Catalan crisis and Spain's outstanding economic performance, suggest that a one-notch upgrade is likely in line with Fitch earlier this year. Anticipation can cause some Spanish outperformance today in the peripheral spectrum.

Asian stock markets lose up to 5% overnight. Apart from the escalating trade conflict, US President Trump replaced his national security advisor by another foreign policy hawk. The US Note future slightly extends gains, while the yen profits from safe haven flows on currency markets. The US 10-yr yield tests important support around 2.8%. We expect a stronger opening for the Bund.

Today's eco calendar contains US durable goods orders and speeches by 4 Fed governors. The most interesting Fed speech is the one from Atlanta Fed Bostic, who is a voter in favour of 2-3 rate hikes in 2018. These items probably won't impact trading in light of recent events. All eyes remain on stock markets. An intensification of the sell-off could generate more safe haven flows into core bonds. The nature of the stock market root suggests though that this link might break at one stage. If China responds for example by reducing or halting US Treasury purchases, it might backfire (US Treasury sell-off instead of safe haven buying), especially with the prospect of increasing US twin deficits. We won't row against the tide yet, but keep a close eye on the link. In any case, the underperformance of the US Note future against the Bund can continue.

After the Fed meeting, we advocated corrective action in the US 10-yr yield towards 2.8%. The test is currently ungoing. We don't anticipate a break lower, but won't set-up new short positions with too much uncertainty looming ahead of and during the weekend. The German 10-yr yield fell below 0.62% support after the ECB meeting, suggesting a technical correction towards 0.46%-0.48% support (gap open/62% retracement).

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