Monday, 02 October 2017 Headlines US equities had a good run Friday, Asian stocks trade slightly positive too, Catalan separatist leaders

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1 Monday, 02 October 2017 Rates: Catalan headache for Spanish bonds? European markets showed a lot of resilience in the run-up to the Catalan secession vote. Madrid s impertinent behaviour and Catalan President Puigdemont s hint at a unilateral declaration of independence might change that today, resulting in Spanish spread widening and an outperformance of the Bund vs the US Note future. Currencies: EUR/USD modestly lower as Catalan tensions persist The dollar outperforms this morning, supported by higher US yields. EUR/USD returns south after a rebound at the end of last week. Tension in Catalonia might be slightly negative for the euro, but USD strength prevails. Will the US ISM be strong enough to reactivate the reflation trade and support further USD gains? Calendar Headlines US equities had a good run Friday, closing the quarter with moderate gains (and new highs for S&P and NASDAQ). IT is still the outperformer. Asian stocks trade slightly positive too, but the Golden week keeps many bourses closed. Catalan separatist leaders signalled they may be moving toward unilateral independence as early as this week after many activists were injured as they tried to stop Spanish police from shutting down an illegal referendum. The Q3 Japanese Tankan report nurtured economic optimism. Large and small manufacturing firms were much more optimistic than expected about the current situation and the outlook. Large and small non-manufacturing firms results were respectively slightly better and slightly worse than expected. The official Chinese PMI survey showed an improvement of sentiment. The manufacturing PMI was up to 52.4 from 51.7 in August and the nonmanufacturing PMI rose to 55.4 from The Caixin PMI (more private sector oriented) slowed though to 51 from 51.6 (51.5 expected). President Trump admonishment of Secretary of State Tillerson for wasting his time in seeking negotiations with N-Korea highlighted differences within the administration on how best to get Kim Jong Un to halt his nuclear program President Trump met with former Fed governor Warsh to discuss potentially nominating him as the next Fed chairman. Warsh has a more hawkish instinct that current chairwoman Yellen. It moved bond markets with a bear flattening. EMU & UK PMI and the US ISM surveys are the key eco indicators today. ECB Praet, Fed Kaplan speak (little impact?) and UK PM May speak. S&P Eurostoxx 50 Nikkei Oil CRB Gold 2 yr US 10 yr US 2yr DE 10 yr DE EUR/USD USD/JPY EUR/GBP P. 1

2 Rates Monday, 02 October 2017 US Treasuries remain under pressure German bonds hold on to slight gains US Treasuries sell off on speculation Warsh will be next Fed chair Peripheral yield spreads narrow despite Catalan referendum US yield -1d 2 1,48 0,03 5 1,95 0, ,33 0, ,88-0,01 DE yield -1d 2-0,69 0,01 5-0,27-0, ,46-0, ,30-0,03 EMU unemployment rate to decline Upside risks for US ISM business confidence German bonds initially continued to correct higher on Friday, but gains evaporated in US trading. US Treasuries were hit by a very strong Chicago PMI and speculation that former Fed governor Warsh is in the running to succeed Yellen as Fed chair. Warsh is more hawkish than Yellen. It is obvious that the bearish mood on the US market is a degree higher than in the Bund market. The technical picture of the Bund shows a potential ST bottoming out, as it manages to stay above support and didn t break the 62% retracement. The T-Note future on the contrary remains below similar support and lost the 62% retracement, suggesting a full return to , the start of the summer rally. Intraday, the Bund s upward correction resumed in early European dealings and bonds managed to hold on to modest gains, at least until the mid-us session. After the sharp sell-off for the best part of September, core bonds were ripe for an upward correction and that started Thursday and continued on Friday, at least for the German bonds. The rise of Bunds coincided with falling equities and a rising EUR/USD, but when equities turned north, it didn t affect Bunds. The Bund made a last minor move higher on the weaker-than-expected EMU headline and core inflation. US Treasuries lagged Bunds on their way higher, but rose sluggishly to new minor intraday highs after the release of slightly lower-than-expected US PCE deflators. However, the sell-off resumed after the strong Chicago PMI and the Warsh story. The curve flattened as the Warsh pushed especially yields at the shorter end up. Focus on manufacturing business surveys The September EMU manufacturing PMI business sentiment is expected to be unrevised at a very high 58.2, versus 57.4 in August. We agree with consensus and don t expect a noticeable revision (which occurs only very rarely). Some national data will be published for the first time, but global bond markets will unlikely react to the report. The EMU unemployment rate is expected to have fallen to 9% in August from 9.1% in July. Strong growth supports employment and pushed the unemployment rate lower. As the unemployment rate was 9.1% for 2 months, a decline in September is likely. The unemployment rate peaked at 12.1% in 2013 and has fallen steadily since. The US manufacturing ISM is expected to have declined to 57.5 from August s 58.8, which was near the peak of the previous cycle (2007). While this makes us cautious, regional surveys, including Friday s Chicago PMI, showed unison progress. So, the risks are nevertheless on the upside of consensus. Af T-Note future (black) & S&P future (orange) (intraday): US Treasuries hard hit by speculation that former Fed governor Warsh may succeed Yellen as Fed chair (and strong Chicago PMI). US-German 10-yr yield spread widens since early September (from 172 to 186 bps). P. 2

3 R2 163,43-1d R1 161,98 BUND 160,84 0,21 S1 160,49 S2 159,80 Germany, Spain and France tap market this week This week s scheduled EMU bond supply comes from Germany, Spain and France. The German Finanzagentur kicks off on Wednesday by tapping the on the run 10-yr Bund ( 3B 0.5% Aug2027). The French Treasury taps two existing OAT s (1% Nov2025 & 2% May2048) and creates a new one (0.75% May2028) on Thursday for a combined B. The Spanish debt agency launches a new 5- yr Bono (0.45% Oct2022) and taps the off the run Obligacion (6% Jan2029). The amount on offer still needs to be announced. Catalan headache for Spanish bonds? Risk sentiment on Asian stock markets (China closed) is rather positive overnight. The trade-weighted dollar extends its correction higher and the US Note loses some ground. We don t expect a weaker opening for the Bund though as the outcome of the Catalan referendum might interfere with Asian risk sentiment. European markets showed a lot of resilience in the run-up to the Catalan secession vote. Madrid s impertinent behaviour and Catalan President Puigdemont s hint at a unilateral declaration of independence might change that today, resulting in Spanish spread widening and an outperformance of the Bund vs the US Note future. Apart from Catalan headlines, investors will keep the US manufacturing ISM in mind. Risks are on the upside of expectations, which is negative for US Treasuries. After the FOMC meeting, we concluded that US Treasuries re-entered a sell-on-upticks phase as the Fed confirmed its view on 2017/2018 interest rate policy. A December rate hike isn t fully discounted yet (70%). We hold a sell-on-upticks view in the Bund as well as the ECB s normalisation process slowly takes off and as speculation on the future of APP will rise in the runup to the October 26 ECB policy meeting. From a technical point of view, the US Note future is heading for a complete retracement of this Summer s rally ( target). Losses in the Bund are smaller so far, but we also eye a return towards in first instance (62% retracement) and afterwards. German Bund: Downtrend is not broken, but outperformance vs US Note future (European political risk?) US Note future: heading for full retracement of Summer rally P. 3

4 Currencies Dollar rebound to resume? Dollar corrected slightly further Several Asian markets are closed Dollar is again better bid R2 1,2225-1d R1 1,2167 EUR/USD 1,1814 0,0028 S1 1,1662 S2 1,1311 US and EMU eco data to be strong Data might be positive for the dollar. Fall-out from the Catalonia referendum is wildcard. Impact on the euro limited? On Friday, the dollar corrected slightly further lower after eking out gains earlier last week. However, the move petered out as core/us yields rose later in the session. US eco data were mixed and had no lasting impact on USD trading. EUR/USD returned temporary north of the previous range bottom, but closed the session at USD/JPY finished the quarter at Overnight, several Asian markets including China are closed. Chinese PMI s were fairly strong. Still, the PBOC eased the reserve requirements from lending to small companies. This news helps regional sentiment. The Japan Tankan confidence report was constructive with especially manufacturing and smaller nonmanufacturing firms more optimistic.. The headline manufacturing index improved from 17 to 22. There was no reaction of the yen. USD/JPY profits from overall USD strength. Markets are pondering the chances/potential impact of a US tax cut. There is also speculation that Trump might choose a more hawkish new Fed-chairman. EUR/USD declines to the area. USD strength prevails, but there might also a minor fall-out from the tensions in Catalonia. In EMU, the manufacturing PMI is to be confirmed at a very strong The EMU unemployment rate is expected to have declined to 9% in August from 9.1%. In the US, the manufacturing ISM is expected to have declined to 58 from August s 58.8, which was near the peak of the previous cycle (2007). Regional surveys, including Friday s Chicago PMI, were strong. So, the risks are on the upside of consensus. The dollar rallied last week, as investors realised that the chances on a Dec. Fed rate hike have risen and as the US government stepped up its efforts to put the tax reform on the rails. Both factors propelled US yields and the dollar, but the dollar rebound ran into resistance at the end of last week. The dollar clearly needs good eco news and higher US yields. A strong US manufacturing ISM and a constructive risk sentiment might be slightly supportive for US yields and for the dollar. We also keep an eye on the developments in Catalonia/Spain. The tension won t help the euro, but for now we think it won t be a source of substantial euro losses. It looks like the dollar might start the week with a cautious positive bias. EUR/USD revisits range bottom, but test rejected. USD/JPY extends gradual rebound in the 1.08/ range P. 4

5 From a technical point of view EUR/USD hovered in a consolidation pattern between and It took time to break below the range bottom, but the break occurred earlier last week. There was some hesitation in the USD rebound at the end of last week, but EUR/USD closed below the previous range bottom. The rise in US yields looks solid and may support the USD rebound. Next support in EUR/USD comes in at The day-to-day momentum in USD/JPY was constructive recently, but it was primarily due to yen weakness. USD/JPY regained the /95 previous resistance, a short-term positive. The day-to-day momentum remains constructive. The correction top is the next important reference. Sterling still looking for a clear trend. R2 0,9415-1d R1 0,9307 EUR/GBP 0,8820 0,0052 S1 0,8743 S2 0,8657 On Friday, markets focused on two negative eco topics. UK Q2 Y/Y figure was reduced from 1.7% Y/Y to 1.5% Y/Y due to downward revisions in Q3 and Q4 of At same time, output growth in the key services sector declined in July. Sterling already felt some headwinds in the run-up to the data and the move accelerated afterwards. EUR/GBP extended its rebound north of Admittedly, part of this move mirrored an overall rise of the euro. EUR/GBP closed the session at Cable closed the session at In the weekend, the rift between UK PM May and foreign Secretary Boris Johnson on Brexit flared up. For now, the issue has no big negative impact on sterling. Overnight, sterling is losing slightly ground against an overall strong dollar, but gains a few ticks against the euro. The topic will remain in the spotlights during the conference of the Tories that ends Wednesday. Today, the UK manufacturing PMI is expected to decline from 56.9 to However, this is still a good level that allows the BoE to raise rates if deemed necessary. So, the market context looks neutral for sterling (EUR/GBP) at the start of the week. EUR/GBP made an impressive uptrend from April to set a MT top at late August. UK price data amended the dynamics and hawkish BoE comments reinforced a sterling rebound. Medium term, we maintain a EUR/GBP buy-on-dips approach as we expect the mix of euro strength and sterling softness to persist. However, the prospect of (limited) withdrawal of BOE stimulus puts a solid floor for sterling ST term. We look how far the current correction goes. EUR/GBP is nearing support at and , which we consider difficult to break. We gradually look to buy EUR/GBP on dips. EUR/GBP: downtrend shows tentative signs of slowing. GBP/USD: drifting off the recent high. P. 5

6 Calendar Monday, 02 October Consensus Previous US 15:45 Markit manufacturing PMI (Sept, final)) :00 ÏSM manufacturing (Sept) :00 ISM manufacturing prices paid (Sept) :00 ISM manufacturing new orders (Sept) 0.3%/1.5% 0.1%/1.4% 16:00 Construction spending (Aug) M/M 0.4% -0.6% Japan 01:50 Tankan large manufacturing Index (Q3) A :50 Tankan large manufacturing outlook Index (Q3) A :50 Tankan Large Non-manufacturing Index (Q3) A :50 Tankan Large Non-manufacturing outlook Index (Q3) A :30 Nikkei Japan PMI (Sept., final) A UK 10:30 Markit manufacturing PMI (Sept) EMU 10:00 Markit manufacturing PMI (Sept final) :00 Unemployment rate (Aug) 9% 9.1% Germany 09:55 Markit manufacturing PMI (Sept final) France 09:50 Markit manufacturing PMI (Sept final) Italy 09:45 Markit manufacturing PMI (Sept) :00 Unemployment rate (August) 11.2% 11.3% Spain 09:15 Markit manufacturing PMI (Sept) Sweden 08:30 Swedbank manufacturing PMI (Sept) Events 10:00 UK PM May speaks on BBC TV 14:00 ECB Praet speaks in London (at Money & macro finance conference) 20:00 Fed Kaplan speaks in El Paso (no Q&A) P. 6

7 10-year Close -1d 2-year td -1d Stocks Close -1d US 2,33 0,03 US 1,48 0,03 DOW 22405,09 23,89 DE 0,46-0,02 DE -0,69 0,01 NASDAQ 6495,959 42,51 BE 0,73-0,03 BE -0,53 0,01 NIKKEI 20400,78 44,50 UK 1,37-0,01 UK 0,47 0,01 DAX 12828,86 124,21 JP 0,08 0,01 JP -0,10 0,02 DJ euro ,85 31,21 IRS EUR USD GBP EUR -1d -2d USD -1d -2d 3y -0,04 1,86 0,92 Eonia -0,3490 0,0110 5y 0,25 2,00 1,10 Euribor-1-0,3720 0,0000 Libor-1 1,2322-0, y 0,91 2,29 1,42 Euribor-3-0,3290 0,0000 Libor-3 1,3339-0,0011 Euribor-6-0,2730 0,0000 Libor-6 1,5060-0,0034 Currencies Close -1d Currencies Close -1d Commodities Close -1d EUR/USD 1,1814 0,0028 EUR/JPY 132,92 0,51 CRB 183,09 0,10 USD/JPY 112,51 0,17 EUR/GBP 0,8820 0,0052 Gold 1284,80-3,90 GBP/USD 1,3398-0,0044 EUR/CHF 1,1440 0,0006 Brent 56,79-0,37 AUD/USD 0,7834-0,0022 EUR/SEK 9,6253 0,0638 USD/CAD 1,2472 0,0044 EUR/NOK 9,4064 0,0497 Contacts Brussels Research (KBC) Global Sales Force Piet Lammens Brussels Peter Wuyts Corporate Desk Mathias van der Jeugt Institutional Desk Dublin Research France Austin Hughes London Shawn Britton Singapore Prague Research (CSOB) Jan Cermak Prague Jan Bures Petr Baca Bratislava Research (CSOB) Marek Gabris Bratislava Budapest Research David Nemeth Budapest ALL OUR REPORTS ARE AVAILABLE VIA OUR KBC RESEARCH APP (iphone, ipad, Android) This non exhaustive information is based on short term forecasts for expected developments This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice. P. 7