Bonds Weekly Outlook & Strategy - 3-7 Sep
Italian bonds benefited on Monday from a small relief rally after Fitch's decision to only cut Italy's credit rating outlook to negative and to keep the country's rating unchanged (for now) awaiting greater clarity on Italy's actual fiscal plans. Reassuring statements by Italy's Finance Minister Giovanni Tria also helped despite the ongoing uncertainty and political debate around the 2019 budget plan which should be unveiled by the end of September.
Italian 10y yields were 4.5bp lower on the day at 3.175%, outperforming 10y Bunds by 5bp and 10y Spain and Portugal by around 1bp while German 10y paper traded 0.5bp cheaper at 0.33% while UK Gilts richened by 1bp at 1.415% after a weaker than expected August Manufacturing PMI.
US markets are closed today for the Labor Day holiday after 10y Treasury yields ended last week at 2.86%. With the dregs of month end to clear, the market had little choice but to stay defensive given the tough news backdrop (Trump's Thursday broadsides, ongoing EM stress and the wait for Fitch on Italy). US10s all but fully reversed the week's early rise, if holding up shy of the prior week's 2.81%~ low.
In quieter times, Friday's US payrolls would be the week's showcase event. With all the current headline and price action churn in EM and other risk assets at present however, that looks like being very much a secondary concern this week.
Instead, the big elephant in the corner now thanks to Trump's latest pre-election trade tirades is the Sep 6 deadline on consultation for further China tariffs. Trump has threatened to act as soon as possible so it is hard to imagine the market will be able to relax all week and Friday's US numbers could end up being overshadowed by the latest headlines. It's at the point now where the market is really only hoping that the administration at least goes down the line of at least some combination of delayed implementation, tariffs at the low end (i.e. 10% rather than 25%) and some phased introduction, rather than going the shock and awe root of a heavy hit on $200bn.
At the moment, the somewhat false calm in USTs continues, upside yield tests on the back of ongoing Fed tightening assumptions getting rejected, and 30s in particular still showing there is demand for paper above 3%. And yet, the recent yield floors holding too will risk jolts lack any killer blows. 2.8%~ is still holding the floor on 10s, albeit granted any shock headlines jolts could quickly spike to 2.75-0% if the looser shorts are prised out.
One factor in general is that the market is at least now emerging from what has been the seasonal hot spot for USTs of August. This year saw yield declines that were again in keeping with the double digit median and average declines for this month in the last 10 years. This now reverts to a more neutral September typical performance. None of that will matter if the news flow sees a decisive shift one way or other but there is perhaps less of an overt tailwind.
Big picture, perhaps traders in all markets are left waiting for the mid-term elections to see if clearing this event, and the back-to-the-wall belligerent Trump looking to defend his presidency, will see any more significant turn in favour of a less negative EM environment and thus a heavier and more policy focused UST market.
In Europe, the other early risk focus will be regarding how BTPs emerge to start the week following Fitch's ratings decisions after Friday's close. The situation with BTPs remains unchanged - Italy now offers quite attractive yield pick up for players that might want to hedge cycle/duration risks in bunds in exchange for the credit risk in Italy. 3%+ for IT10s is in a very small universe of sovereign bonds. By Q4, if the Budget is not too scary and ratings agencies hold fire, then accumulators of the illiquid yield spikes may be sitting pretty.
All that said, it is hard to deny that the market is relying on a quick improvement this week if the charts are not to end up looking undeniably ugly near-term. IT10s have cleared the prior Aug 3.2% worst levels so are moving back into the June spike to 3.38/9%, not immediately good from a chart perspective. Those highs though do then offer much tougher resistance. And spread wise, the push in IT-DE 10s to new highs of 292bp~ doesn't look too clever on the charts, as if we do continue on above this break level and 38% mark in the 280s, then 50% retracement of the post financial crisis tightening comes in at just over 325bp.
Bunds have looked a bit wary of chasing the risk gyrations again and it still looks the case that the market is wary of how rich prices are being pushed by the risk concerns. 0.3-0.25% remains the base on DE10s that has been proving the limit on safety action but it is hard to rule out yet another run into that zone to retest if the news flow remains challenging. 0.42% has proved to be the limit of sellback attempts of late, well prior to re-setting to 0.5% if and when we can finally escape the trade threats.
After Monday's U.S. holiday, Tuesday sees July construction spending and Aug's ISM manufacturing index, which we expect to be almost unchanged at 58.0 versus 58.1 in July. On Wednesday July's trade deficit should increase to $50.4bn from $46.3bn in line with signals from advance data on goods.
Thursday's ADP report on private sector employment should see a slower rise of 175k in Aug after outperforming payrolls in July. Later July factory orders and Aug ISM manufacturing data is due. The latter should bounce to 57.0 from a weaker 55.7 in Jul
The highlight of the week is Friday's non-farm payroll for Aug when we expect a rise of 180k, a pick up from July's 157k when some one-time negatives restrained the data. We expect an unchanged unemployment rate of 3.9% while average hourly earnings should rise by a modest 0.2%, leaving yr/yr growth stable at 2.7%.
The Bank of Canada should leave rates unchanged at its Wednesday meeting. The statement is likely to see the economy as broadly on track and look to continued gradual tightening, but the BoC is unlikely to see a need to tighten on a second straight meeting. On Thursday BoC Senior Deputy Governor Wilkins will speak.
There are two significant Canadian data releases due. On Wednesday, before the BoC decision, the trade deficit should correct higher to C$1.0bn from a significantly narrower C$0.63bn in Jun. On Friday Aug employment should see a 5k correction lower after a 54.1k surge in July that was less impressive in its details. Unemployment should correct higher to 5.9% from 5.8%.
The final EZ manufacturing PMI surveys started the data week on Monday. The EZ survey was confirmed at 54.6 (July: 55.1) with Germany at 55.9 (July: 56.9) and France at 53.3 (July: 53.3).
The final services and composite PMI surveys will then follow on Wednesday. In line with the flash, composite EZ is expected at 54.4 (July 54.3) and services at 54.4 (July 54.2). In Germany the services survey is expected at 55.2 (July 54.1) composite at 55.7 (July: 55), while in France services is seen at 55.7 (July: 54.9) composite at 55.1 (July: 54.4).
On Thursday, focus will fall on German July industrial orders which we expected will rise by 1.5%m/m following the extremely weak 4% m/m fall in June.
German production data will then be out on Friday, where we look for a 0.5% m/m increase after a 0.9% m/m fall in June.
The third estimate of EZ Q2 GDP is also released on Friday, expected to be confirmed at 0.4% q/q, 2.2% y/y.
The data schedule goes back into full(er) swing this week in the UK centred on the array of PMI releases. On Monday, the August manufacturing headline PMI came in below consensus at 52.8 vs. 53.9 in July when it declined by 0.4 points, therefore breaking below the average readings of the last 3-4 months.
Tuesday's Construction PMI may see a correction back, however after what may have been a weather induced surge in the previous month. On Wednesday, the August Services PMI is also seen consolidating, albeit at 53.5 but only after the more marked correction back seen in the previous month which saw an actual drop of 1.6 points. That drop more than unwound the surprising gain seen in June with the ensuing three-month low also taking the headline reading below the series' long-term average.
Otherwise, it's the Riksbank interest rate decision Thursday. We expect the repo rate to be left unchanged at -0.50%. In Australia, Tuesday sees the RBA meeting too, but perhaps of great interest is the Q2 GDP where a 0.7% gain is expected by the market versus Q1 2018. Additionally, Monday sees the release of the July retail sales figures.