Markets will further digest the FOMC decision

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Yesterday, global core bond trading was uneventful in the run-up to the FOMC decisions. The Fed decided to end its QE-3 programme (final $15B taper) but also tweaked its forward guidance. The “considerable time period” remains, but the Fed added that the lift-off will be data-dependant. On top, the FOMC was less concerned about the risk of too low inflation and sounded more upbeat on the economy (For a full review, see our Flash report).

Overall, there was a clear hawkish shift compared with the previous meeting. At the end of the session, the US yield curve bear flattened with yields 8.7 bps (2-yr; including benchmark change), 6.9 bps (5-yr) and 2.1 bps (10-yr) higher. The 30-yr yield shed 1.8 bps. The Fed Funds strip curve bear steepened (see graph) with a first rate hike now discounted in December 2015 (Feb 2016 ahead of the meeting).

Today, the eco calendar is interesting, both in the US and EMU with the first estimate of US Q3 GDP, US jobless claims, the preliminary estimate of German HICP inflation for October and EC confidence indicators. Fed Chairwoman Yellen is scheduled to speak as are ECB’s Linde and Liikanen. On the supply front, Italy and the US tap the market.

In Q3, US economic growth is forecast to have slowed after expanding at its strongest pace in 2.5 years in Q2. The consensus is looking for a growth figure of 3.0% Q/Q annualized, down from 4.6% Q/Q in Q2. Personal consumption, net exports and non-residential investments probably contributed to growth, while inventories and residential investments are forecast to come out broadly flat.
We stick with the consensus view. In the euro zone, German inflation is forecast to have increased slightly in October, from 0.8% Y/Y to 0.9% Y/Y, despite the sharp drop in the oil price. The uptick is mainly due to negative base effects as HICP inflation is expected to have dropped by 0.1% from the previous month.
Ahead of the national reading, the regional data will already give an indication. We believe that the risks, if there are any, might be for a downward surprise.
Also in the euro zone, European Commission’s economic confidence will be interesting after the mixed confidence indicators earlier this month. Economic confidence is forecast to drop marginally from 99.9 to 99.7. We believe however that the risks are for a stronger outcome following an uptick in consumer confidence and also the PMI’s and Italian business confidence surprised on the upside. Finally, US initial jobless claims are projected stay close to their recent trend (285 000 from 283 000).

The Italian treasury taps the on the run 5-yr BTP (€2-2.5B 1.50% Aug2019) and 10-yr BTP (€2-2.75B 2.50% Dec2024). The past fortnight, both bonds cheapened significantly in ASW-spread terms. On the Italian curve, the 5-yr BTP trades normal whereas the 10-yr BTP is rich. Overall, we believe the auctions will be plain vanilla in the wake of the ECB’s AQR results which gave a negative connotation for Italian banks. Additionally, the Italian treasury taps the on the run 5-yr floating rate CCTeu (€1.5-2B Euribor +0.8% Dec2020) today.

In the US, the treasury continued its end-of-month refinancing operation with a weak $15B 2-yr FRN auction and a sloppy $35B 5-yr Note auction. Demand was scarce ahead of the FOMC decision. The 5-yr auction had a large tail and the bid cover was the smallest in years (2.36 versus 2.78 average this year). Also bidding details were mixed. The indirect bid held up reasonably well, but the dealer bid collapsed. Today, the Treasury ends with a $29B 7-yr auction. The 7-yr WI currently trades around 2.015%.

Overnight, Asian equity markets trade mixed to positive. Like WS yesterday evening, they hold strong despite the hawkish FOMC statement. The US Note future trades flat (no additional losses for now), suggesting a neutral opening for the Bund.

Today, markets will further digest the FOMC decision. The hawkish shift is a negative for (especially shorter-term) US Treasuries. The Fed made a lift-off date officially data-dependant which means markets will be more sensible to US eco data. Today we get US GDP and weekly claims, but next week will be more interesting/key with ISM’s, ADP and payrolls. A speech by Fed chairwoman Yellen is a wildcard. In EMU, German inflation data and EC confidence indicators could also trigger some volatility.

Technically, the German Bund remains below the uptrend line since June. This is a first indication that the bull run slows. A sustained drop below 149.91 would change the ST technical picture to neutral. For the US Note future, the FOMC verdict opens the way for a new downleg especially when accompanied by stronger US eco data.