Solid 7-yr US Note auctions

Rates

Upward US Q2 GDP revision weighs on US Treasuries

Yesterday, global core bonds traded relatively stable despite a continuation of the risk-on sentiment which pushed equities, commodities and USD higher.
Volatility remained high in the US equity session, which was to a lesser extent reflected in the US Treasury market, but less so in the Bund market. Core bonds not only had to cope with a continuation of the risk rally, but also with strong eco data. Support came from a solid US 7-yr auction and some end of the month extension buying. Summarizing, core bonds held up well in the face of positive risk sentiment. In a daily perspective, US yields rose 1 to 1.7 bps in the 2-to-10-yr sector, the shorter end slightly underperforming, while the 30-yr fell 0.8 bps.
In Germany, yields rose by 0.6 to 6.5 bps, steepening the curve, but part of the rise was due to catching up with the US overnight. During the session, yield changes were small with the exception of the 30-yr (up 4 bps). On intra-EMU bond markets, Germany underperformed both peripherals (- 9-11 bps for Italy/Spain/Portugal) and semi core (-2 bps). An asymmetric reaction: peripherals gain more during risk-on than they lose during risk off.

Interesting eco calendar

In August, German HICP inflation is forecast to have stabilized at 0.1% Y/Y following already a stabilization in July. On a monthly basis, HICP is expected to have dropped by 0.1% M/M. We believe that the risks are for a downward surprise due to the recent drop in oil and other commodity prices. Following an uptick in July, EC’s economic confidence is forecast to have dropped slightly in August, from 104.0 to 103.8. According to the 1st estimate, consumer confidence improved slightly and also other business confidence indicators picked up this month. We believe therefore that EC’s economic confidence might be somewhat stronger too as we don’t expect a substantial market reaction on the Chinese tensions (yet). In the US, both personal income and spending are forecast to have started the Q3 on a strong footing. Both income and spending are expected to have increased by 0.4% M/M. We have no reasons to distance ourselves from the consensus. The PCE deflator however is expected to have increased by 0.1% M/M with the annual rate unchanged at 0.3% Y/Y. Also the core PCE is expected unchanged, at 1.3% Y/Y. For both price indices, we see upside risks following encouraging signs in the CPI data. Finally, a limited upward revision is expected in U. of Michigan consumer confidence, from 92.9 to 93.0, but still marginally down from 93.1 in July. We believe that the risks are for an upward surprise (lower oil prices).

Solid 7-yr US Note auctions

The US Treasury ended its end-of-month refinancing operation with a solid $29B 7-yr Note auction. The auction stopped easily through the 1:00 pm bid side and the bid cover (2.53) was the best since last November. Bidding details were plain vanilla. The solid auction followed disappointing auctions earlier this week.

Mester sounds similar warning

Cleveland Fed Mester said that recent market turmoil grabbed her attention, but didn’t alter her view that the US economy is ready for a modest increase in interest rates this year. Her comments reflect recent warnings from Atlanta Fed Lockhart and NY Fed Dudley, who said that the case for a September hike became less compelling. Recent market turmoil pushed market expectations of a first Fed rate hike into 2016. We don’t rule out a September lift-off yet though, if global markets stabilize the next few days and data remain strong. Mester’s longer run view on rates and growth could be shifted lower though at the next meeting, in light of persistently slow productivity growth. Her longer term interest rate “dot” currently stands at 3.75%, but a decrease to 3.5% is likely. In June, the median dot for the longer term rate was 3.75%, but it was a very close call. One downgrade would, ceteris paribus, lower the median dot as well. That would be keep the longer end of the US yield curve under downward pressure. Tomorrow, investors get another update on the US economy and monetary policy when Fed Vice Chairman Fischer speaks at Jackson Hole.

Today: Positive bias core bonds

Overnight, Asian stock markets build on yesterday’s WS strength though gains are somewhat less outspoken for China despite rumours that the country could use money from pension funds to invest (underpin stock market). Japanese eco data were a mixed bag while a Vietnamese auction failed (first failure since EM came under pressure). The US Note future trades marginally higher.

Today, the eco calendar heats up. German CPI is expected to turn negative again with downside risks to expectations. This will likely trigger all sorts of QE-2 related headlines and is positive for the Bund. Risks to US eco data are on the upside of expectations, but ahead of the weekend, with supply out of the way and given some end-of-month extension buying, we have a positive bias for US Treasuries today. Nevertheless, we expect the recent highs in the Bund (156.49) and US Note future (129-28+) to hold, even if volatility on equity and commodity markets would return. Return action could be an opportunity to start a cautious sell-on-upticks strategy.