US payrolls in the picture

Core bonds going nowhere ahead of US payrolls

Core bond had a fairly boring session and closed nearly flat to slightly higher, as eco data couldn't make the difference. Around noon, a Reuters article signalled ECB unease about the strength of the euro. The euro weakened and the ECB concern could have been the trigger for a minor move higher of the Bund. Equities and crude oil rallied, but didn't impact bond trading. Some late end-of-month buying may have lifted longer-dated US Treasuries at the end of the session. In a daily perspective, US yields were flat (2-yr) to 1.4 bps (10-yr) lower, while German yields were virtually unchanged (changes between flat and 0.3 bps). The calmness in the bond market convinced some investors to look to the "riskier" peripheral bond markets. In the intra-EMU bond market, 10-yr yield spreads versus Germany narrowed modestly, by 2-to-3 bps.

US payrolls in the picture

All attention will go the US eco releases and more in particular the August payrolls and the ISM. Consensus expects a 180 000 net increase of employment, following a 209 000 increase in July, a stabilisation of the unemployment rate (4.3%) and a modest rise of the Average Hourly Earnings (AHE) by 0.2% M/M and 2.6% Y/Y. We put the risks to the upside of consensus. First, the pace of monthly gains has picked up in recent months in line with economic activity data. The employment sub-indices of the services and manufacturing ISM's declined in August, but stay at high levels. The temporary help sectors' results for July were very strong, which normally lifts overall payrolls. Initial claims stick at very low levels and the ADP report showed a strong 209 000 net private gain. However, it is prudent to be cautious for the August report, as the August results had a systemically downside bias in the last 10 years, especially in the first estimate. The unemployment rate likely stabilized at 4.3%. In July it was actually 4.35%, meaning that an unusually large 0.1%-point decline is needed to bring it to 4.2%. The AHE pose problems (calendar quirk). The survey week includes the 12th of the month, which is in case of August is the earliest possible survey period (7-to 12 August, Saturday). When the 15th of the month is not included, it risks dampening the wage growth. Concluding: while we think that the labour market is thriving, there are still more than usual question marks about the outcome of the August payrolls report. We expect a strong ISM business confidence report as regional reports have been strong too, but assess the consensus estimate as reasonable.

Can US payrolls pull US 10-yr yield away from 2.1%?

Asian stock markets record similar gains to WS yesterday (+0.25%-0.5%) with Japan underperforming (flat). Brent crude manages to hold on to yesterday's impressive gain (+$2/barrel) and trades around $52.7/barrel. The US Note future gives no specific guidance, suggesting a neutral opening for the Bund.

Today's eco calendar heats up in the US with the key payrolls report. We expect a strong outcome (also for unemployment rate and average hourly earnings) even if statistical distortions aren't excluded. That's a negative for US Treasuries. Brent crude is finally impacted by hurricane Harvey (gasoline prices already skyrocketed) which is negative as well. The US long weekend ahead could limit today's damage with some investors probably wanting to play it safe. If our favoured scenario plays out, US Treasuries should underperform German Bunds.

From a technical point of view, the US Note future tested the contract high in combination of a test of 2.1% support in the 10y yield. A break didn't occur. A potential trend reversal signal appeared, but it proved to be false. In case of stronger US eco data today, which we expect, markets could make a second attempt to push yields away from that key support. It could mark the start of a correction higher/consolidation with more neutral positioning going into key September central bank meetings.

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