Forex - Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019

 21:51 (GMT) 07 Jun

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Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019 (0101-LXHZ-C01)

Bonds Weekly Outlook & Strategy, 10-14 June

- Significant Fed easing priced in at front end of US curve points at greater yield upside on positive surprises than downside from potentially weaker data

- As ECB easing remains unlikely given current exceptionally negative nominal and real Euro area yields, rising concerns about current bond valuations may favour further spread compression

- Trading around the next data releases throughout the coming week

Market Recap

US Treasuries gained following a disappointing May labour market report which saw non-farm total payrolls increasing by just +75k and April's 263k revised lower to 224k while average earnings rose by 0.2% vs. 0.3% consensus wit the only 'positive' being unemployment staying at 3.6%. Nevertheless, US bond gains were relatively contained with 10y Treasury yields closing 3bp lower a 2.09% after plunging by 7bp to 2.05% in the aftermath of the labour market data releases before rebounding off the key 2.06% resistance amid signals of improvements in trade negotiations with Mexico. The 2y-10y slope was virtually unchanged at +24bp while long bonds outperformed 10s by 1bp, although failing to convincingly break below 2.575% for a move lower towards 2.50%.

In Europe Italian bonds were the biggest movers with 10y BTPs gaining as much as 19bp in early trading in light of Thursday's details of new ECB 2y loans whose pricing is expected to reignite carry trades particularly on higher yielding Eurozone bonds as political uncertainty in Italy also appears to be fading. 10y Italian yields closed 13bp lower at 2.355% implying a spread of ca. +261bp over 10y Bunds and with 2y-3y paper outperforming by a further 1-2bp. European bonds were generally better bid with other core-periphery spreads also tightening remarkably. Bund yields closed 2bp lower and just 0.5bp off a new historical yield low of -0.265% also helped earlier in the session by a weak German IP reading for April. UK yields were also lower on the day, with 10y Gilts closing at 0.81%, down 1bp from Thursday despite an initial modest rise following better than expected May Halifax house prices.

Market Outlook

A positive week for US bonds as well as for US, European and Japanese equities, supported by the assumption that the Fed and the ECB will follow the example of the RBA and cut rates pre-emptively to support their respective economies against the headwinds of protectionism, has ended leaving all major bond markets trading at new multi-year lows if not historical lows as in the case of Bunds.

Data-wise the last five trading sessions bonds have highlighted the lingering weakness in the UK economy with significant declines in both the Manufacturing and Construction PMIs to below the 50 points threshold with only a small rise in the Services PMI preventing all three indices from flagging a possible contraction (which our economists nevertheless are expecting in Q2). Slower economic activity was also shown in the US by the confirmation of the further plunge in Manufacturing and Services PMIs for May as well as by a contraction in factory orders and business investments in April despite an unexpected rise in the non-manufacturing ISM for May (although mostly due to a rebound from a weak April reading) while job creation was surprisingly soft, although partly correcting very strong payroll additions in April. On the inflation front, against rising prices paid by manufacturers, wages continued to rise modestly notwithstanding the ongoing tightness of the labour market with unemployment remaining at historical lows as well continuing claims and underemployment declining while consumer credit posted a further significant rise.

In the Eurozone the data continued to point at weakness particularly in manufacturing (although with some surprising improvements in some large countries, especially Italy, which nevertheless cannot fully off-set a contraction in Germany) but with broad-based improvements in services probably driving an ongoing decline in unemployment and with GDP data looking as having been increasingly healthy in Q1. Nevertheless, price dynamics remained subdued with both headline and core HICP inflation for May coming 0.1 p.p. lower at 1.2% y/y and 0.8% y/y (0.1 p.p. off the March 2017 low and 0.2 p.p. off the March 2015 all-time low), yet retail sales continued to languish.

Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019 (0101-LXHZ-C02)

The data scheduled for the coming week does not seem to have the potential to change the big picture but could trigger some repricing from overstretched levels. After a likely initial profit taking at the start of Monday's session after a 26bp tightening between 10y BTPs and Bunds since last Monday and a 2.5% weekly gain by Italian equities, a stabilisation in Italian production on Monday could be a catalyst for further outperformance by Italian assets in the first half of the coming week, supported by expectedly conciliatory tones by Finance Minister Tria in Parliament on Tuesday on Italy-EU relations, ahead of the mid-month BTP auctions scheduled for Thursday and the Ecofin meeting due on June 13-14 which may already examine the EU Commission's request to open a disciplinary procedure on Italy for excessive debt, both likely to represent opportunities for some profit taking.

Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019 (0101-LXHZ-C03)

Monday's expected significant weakness in UK GDP data may be one factor driving yields lower at the start of the week in Europe, offsetting any potential upside stemming from any overnight uptick in Japanese Q1 growth. However, given that 10y Gilt futures already broke above the 130.32 and now trade in substantially uncharted territory, we would expect any further upside move to be driven by considerations on 10y yield considerations and may therefore target the next key yield support are of 0.793 corresponding to the early October 16 intraday low.

WE therefore expect the market to be long into the week's UK data as further downside pressure could build following Tuesday's labour market statistics which are also likely to be seen as weak on balance. Nevertheless, a minor disappointment could provide an opportunity to take profits after the rally with Gilt Sep-19 futures testing the 130.32 resistance (0.84% 10y Gilt yield) before targeting a move towards ~129.95 (0.865%) ahead of the release of the US May PPI data on Tuesday and the US May CPI on Wednesday, with the latter likely to be the main market moving event of the week in an otherwise relatively quiet day on the data front which could allow some repositioning of the books ahead of the US inflation figure.

Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019 (0101-LXHZ-C04)

Although headline inflation may well come as low as low at 0.1% m/m on subdued energy prices in May, we expect a rise in core CPI to 0.2% m/m from 0.1% m/m/ in April, which would leave CPI core inflation at 2.1% y/y and relax market concerns about downside pressure on core prices given that the Fed's preferred measure of core inflation, the core PCE, last printed at 1.7% y/y in April. As a result, a consensus print may just be enough to trigger the partial removal of some of the expected 75bp cumulative easing currently built at the front end of the US curve, driving Sep-19 T.Note futures back to 126.23 (corresponding to 2.135% in US 10y yields) before 2.145% and then heading for 126-06 (2.19%-2.20% area).

Conversely, a stronger release could drive US 10y T.Notes to retesting 127-19+ (2.05%) a break of which would see 2.025% and then 2% being tested, suggesting an asymmetric risk profile, with a likely limited near term yield downside of 8bp from current levels vs. a potential upside of 12bp on a stronger than expected release.

Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019 (0101-LXHZ-C05)

We see any further yield downside even more limited for 10y Bunds at current record low negative yields after ECB President Draghi did not sound as dovish as the market had desired at Thursday's press conference, suggesting that without significant downgrades to its own growth and inflation projections (both improved by 0.1 p.p. for 2019 but downgraded by the same amount for 2020) rate cuts may not be justified just yet despite the market already pricing in a 20bp cut to the depo rate by mid-2020.

In the eye of the markets, with new TLTRO loans having disappointed expectations be representing mostly a liquidity back-stop for peripherals banks and issuers, that may leave little more than the announced 6m postponements of the ECB forward guidance for a possible lift-off to justify current yield levels, which may become increasingly sensitive to any upside in macro data releases pointing at an accelerating recovery, particularly in the weaker industrial sector and especially in Germany.

A better than expected Eurozone April industrial production, even if largely anticipated, may still be seen as market negative, helping to push 10y Bund yields upwards above the -0.205% yield resistance level favoured by higher US yields into Friday's release of May retail sales data, which we expect to be on the firm side, followed by better May US industrial production data.

Data & Events

After key final Japanese Q1 GDP data, the week sees two of the most high-profile sets of data for the UK due to be released (Monday's GDP and Industrial Output and Tuesday's labour market statistics) while it will be fairly quiet for the Eurozone. In the US instead the main focus will be on prices with PPI and CPI inflation due to be released on Wednesday followed by May retail sales on Friday.

Fed speakers are likely to be quiet ahead of the Jun 19 meeting while remarks are expected from Band of England's Haldane and Saunders on Monday and Tenreyro and Saunders on Tuesday with Governor Carney also due to speak on Friday. From the ECB front, Bank of Austria's Governor Nowotny will speak on Tuesday followed by ECB member Rehn presenting Bank of Finland forecasts on the same day and new Estonian central banker Muller speaking in Tallin on Wednesday . President Draghi will also speak at a Central Eastern and South-Eastern European Banks conference in Frankfurt on Wednesday followed by ECB vice-President De Guindos (due to speak on global headwinds also in Frankfurt).


Japan releases its final Q1 GDP Key focus which will be the key focus of the week for Japan. Robust capital spending growth in Q1 suggest that there is likely to be some upward revision of the initial print of +0.5% q/q wit consensus at +0.6% q/q implying +2.2% q/qA while private consumption should lag and with prices remaining at +0.2% y/y. The May Eco Watchers survey will also be out on Monday likely showing an improvement in current conditions despite slightly lower expectations.

Italy's industrial production for April will also be released on Monday and should give us an idea of whether the 1% q/q increase recorded in Q1 was a mere temporary rebound or the start of a more positive trend, with consensus looking for some stabilisation with a modest 0.1% m/m increase.

Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019 (0101-LXHZ-C07)

We expect the monthly UK GDP m/m data for April to show a marked weakness, led by industry, resulting in a 0.3% m/m drop, following on from the 0.1% March fall, although more downside risks would chime with our current view of a q/q drop in current-quarter GDP. The main weakness comes from manufacturing where already-reported car production data which showed y/y drops of around 45%, due to maintenance periods having been brought forward because of the original Brexit deadline, which alone translates into something like a 35% m/m fall for April, enough to damage the overall but yet-to-be-published official manufacturing numbers by 3% m/m. Moreover, weakness in overall industrial production may then be accentuated by warm April weather undermining utility production and where North Sea oil production may have slipped too. But given the manner in which companies may have slowed, if not reversed, the inventory build-up given the now-extended Brexit deadline may mean more weakness may have occurred on the factory side. The question, and where the downside risks emanate, is the extent to which other sectors accentuate, or temper, such industry-induced weakness to overall April GDP.


The Bank of Japan releases its May Money supply data

The UK will again be in focus on Tuesday with a mixed messages expected from the May/June labour market statistics. More-clear softer signals in terms of a further slowing in the high-profile average earnings numbers, which we see (at least for the headline number) dropping to a nine-month low of 2.8% y/y, compared to 3.2%, ie down additionally from prior months which at 3.5% were the highest in a decade. Ironically, this will reflect higher single-month estimates, back up to 2.7% for the overall figure while the regular pay single month is seen recovering to 3.2%, these probably having been boosted by the recent rise in hours worked rather than a rise in pay deals. The rest of the data should still see more mixed messages, especially if there is a further drop in vacancies (already at seven-month low). Admittedly, the unemployment rate may hit a fresh cycle-low of 3.8% despite record-high participation (most notably for women). Moreover, in (what have been volatile) employment numbers, another clear but less marked rise is envisaged, probably still partly predicated around self-employment and part-time jobs. This time around, a different perspective on the jobs market arrives in terms of the workforce numbers which measure jobs rather than people in work. Until the end of 2018, they have been offering a soggier picture of employment, but may show some recovery reflecting increased self-employment working already evident in existing data.

Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019 (0101-LXHZ-C06)

In the Euro area the June Sentix survey is likely to show a deterioration in investor confidence as is the May NFIB small business optimism index in the US where May producer prices are also due with an expected 0.2% m/m increase in core PPI but with an expected 0.3% m/m increase in the headline.


The Japanese May PPI is expected to show a much slower growth in producer prices while the April core machinery orders data is expected to point at ongoing weakness with a decline by 1.5% y/y. France Q1 non-farm payroll data will then be released. Given the decline in unemployment observed so far in 2019, the good labour market performance should push employment further up.

Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019 (0101-LXHZ-C08)

After that, the focus will switch to the US with the May CPI releases. We expect a stronger 0.2% increases in the ex food and energy rates while the headline CPI should come at just 0.1%, as late month dips in gasoline and seasonal adjustments are seen as having a restraining impact on the CPI.


Japanese foreign asset purchases and manufacturing data will be released on Thursday followed by UK RICS housing market data which may show more gloomy overtones.

In the Eurozone, final May German HICP inflation is likely to be confirmed at 1.3% y/y, down from 2.1% y/y in April, while the Eurozone industrial production in April is likely to show a slightly larger decline than the -0.3% m/m shown in March. Also due in the US on Thursday are the usual weekly initial claims as well as May import prices.


Japan will release the final reading of the April industrial production while France will release its final CPI and HICP inflation data with the flash estimate confirming the 1.1% y/y headline. Italy will publish May CPI and HICP inflation with the flash estimate seen at 0.9% y/y for the headline and core at 0.5% y/y while April Industrial orders and sales data will give a further indication of future industrial production output.

Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019 (0101-LXHZ-C09)

In the US May retail sales will be closely watched. We expect a 0.6% rise overall, 0.3% ex autos and 0.4% ex autos and gasoline. Also due later on Friday are the May industrial production, preliminary June Michigan CSI and April business inventories, altogether seen on balance leaning on the firmer side.

Bonds Weekly Outlook & Strategy, APAC, 10-14 June 2019 (0101-LXHZ-C10)

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