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Rates

Core bonds lose momentum as stocks rebound

Global core bonds lost their bullish momentum of the previous 2 trading sessions this week as tension on stock markets eased and OPEC reached a production deal. European stock markets rebounded driven by the tormented financial sector.
Consumer confidence slightly disappointed in Italy and Germany while stabilizing in France. The EMU eco data didn't impact trading though. During US dealings, US Treasuries somewhat underperformed after the release of mixed durable goods orders and later on the OPEC deal. ECB president Draghi warned in his testimony that low rates for a long period might carry the risk of overvaluation in asset markets. That's another sign the ECB isn't convinced to go the extra mile with more monetary stimulus in the future. The US 7-year Note auction was plain vanilla.

In a daily perspective, changes on the German yield curve were negligible, while US ones were up to 1.5 bps higher. On intra-EMU bond markets, 10-yr yield spreads versus Germany narrowed up to 2 bps with Greece (-8 bps) and Portugal (10 bps) profiting most of easing tensions. Greek lawmakers approved an omnibus bill that may lead to the disbursement of the next tranche of the bailout and bring ECB Greek bond buying closer. Portugal's Finance Ministry changed the terms of the state's loans to the bank resolution fund, including extending maturities, helping banks avoid having to make extra payments.

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After an unexpected slowdown in August, German HICP inflation is expected to have picked up in September. The consensus is looking for inflation to have accelerated to 0.5% Y/Y in September from 0.3% Y/Y in August. If confirmed, this would be the strongest rate of inflation since May 2015. The increase will be driven by positive base effects. Lower prices for holiday-related goods and services mighty be partly offset by higher prices for school equipment, but overall we see risks for a downward surprise. European Commission's economic confidence dropped one point in August, but a stabilization is expected for September. Earlier released business confidence indicators showed a mixed picture, but for the Commission indicator we see risks for a stronger outcome as consumer confidence already surprised positively and as the indicator fell quite significantly in the month before. In the US, the third estimate of Q2 GDP shouldn't bring any major surprise. A limited upward revision from 1.1% Q/Qa to 1.3% Q/Qa is expected. Jobless claims are expected to edge somewhat higher following a drop to a very low 252 000. We anticipate claims will hold close to recent lows (risks for another stronger report).

Italy concludes this week's scheduled bond auctions

The Italian debt agency sells a new 5-yr BTP (€3.5-4B 0.35% Nov2021) and taps the on the run 10-yr BTP (€2-2.5B 1.25% Dec2026). Grey trading suggests that the new 5-yr BTP will be launched with a 5 bps pick-up in ASW spread terms compared with the previous 5-yr benchmark (0.45% Jun2021). That corresponds with a 7 bps pick-up in yield terms. The 10-yr BTP traded stable in ASW spread terms going into the auction, but is rather expensive of the Italian curve. We expect a steady auction.
The recent flaring up of concerns about the (Italian) banking sector, could weigh on investor demand.

The US Treasury ended its refinancing operation with a plain vanilla $28B 7-yr Note auction and a mediocre $13B 2-yr FRN auction. The 7-yr Note auction stopped just above the 1:00 PM bid side and the bid cover was only modestly below average (2.47). Bidding details showed another lacklustre direct bid while the indirect and dealer bids were very much in line with average.

More upside Brent crude following OPEC deal?

Overnight, most Asian equities gain up to 1% with Japan outperforming on the back of a weaker yen and despite disappointing retail sales. The oil price rally following the production freeze deal stalled in Asia around $48.5/barrel. Fed George, Mester (hawkish dissenters) and Evans (dove) kept their view on monetary policy. The US Note future trades a tad softer suggesting a slightly lower opening for the Bund as well.

Today's eco calendar contains EC confidence data, German inflation, weekly US jobless claims and several Fed speakers (see above). The evolution of the oil price might be the most dominant trading theme though. While OPEC reached a production freeze deal, many details still need to worked out. A further rise of Brent crude and improvement in risk sentiment is intraday negative for core bonds.

Technically, the Bund broke above the upper bound of the post-Brexit trading range (163-165.63). If this break is confirmed by a move of the German 10-yr yield below -0.20%, it's definitely a bullish sign for the Bund.
For now, the break below -0.20% didn't occur though with the German 10-yr yield at -0.14%. A test is nevertheless likely, especially if risk sentiment deteriorates again, meaning that the Bund has more upward potential in the meantime. The trading range for the US Note future is expected to be 130-01+ to 132-05, at least until the first week of October (ISM's/payrolls) or until Washington-based Fed governors change the tone of their public comments (Oct 14, Yellen speech).

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