Rates: Upward bias US Treasuries, outperforming German Bunds?

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1 Wednesday, 03 May 2017 Rates: Upward bias US Treasuries, outperforming German Bunds? Risks for US eco data are on the downside of expectations. Overnight future trading suggests that US equity markets are prone for a downward correction. Oil prices are on the verge of breaking below key support with EIA data scheduled for release. This combination suggests an upward bias for US Treasuries, especially if the Fed is (too) cautious in its statement. Currencies: Dollar still struggles going into the FOMC decision Yesterday, the dollar showed a mixed picture, but in the end the US currency closed near the recent lows against the euro and failed to take out a first resistance against the yen. Today, the eco data might be euro supportive and slightly USD negative. Will the Fed s policy statement be strong enough to give the dollar the highly needed interest rate support? Calendar Headlines US stock markets traded narrowly mixed ahead of Apple earnings. Nasdaq futures are lower overnight on mixed Apple results. Risk sentiment on other Asian markets is mixed, with Japan and South Korea closed. Apple extended its rebound in the latest quarter with rising profit and revenue, but reported tepid iphone demand that adds pressure on the technology giant to deliver a hit with its new 10th-anniversary handset later this year. The latest Republican effort to reshape the nation s health-care system teetered on the brink of collapse in the House, reflecting a new assertiveness by GOP centrists, a group that in recent years has rarely wielded such power. The EU has raised its opening demand for Britain s Brexit bill to an upfront gross payment of up to 100B, according to Financial Times analysis of new stricter demands driven by France and Germany. Ford and General Motors have both reported steeper-than-expected declines in US car sales in April, underscoring fears that the market is cooling faster than anticipated after peaking last year. Crude oil prices bounced back on Wednesday as a decline in US inventories underpinned the market. They still closed more than 1% lower though as a dip in compliance with OPEC efforts to reduce output and near record supplies capped gains. Today s eco calendar heats up with the FOMC meeting, ADP employment report, German employment data and EMU Q1 GDP. Germany sells bonds and ECB Hansson is scheduled to 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 Wednesday, 03 May 2017 Greek assets outperform on reform agreement Minor losses for German bonds and modest gains for US Treasuries Greek bonds sharply outperform on agreement with creditors US yield -1d 2 1,26-0,01 5 1,81-0, ,29-0, ,98-0,03 Downside risks US ADP and ISM reports. Q1 EMU growth strong, but as expected. DE yield -1d 2-0,72 0,02 5-0,37 0, ,32 0, ,11-0,01 FOMC to keep policy unchanged Statement little changed, but some comments about weak Q1? Debate on balance sheet tapering to continue Global core bonds ended narrowly mixed yesterday. The Bund opened lower, catching up with US Treasury losses on Monday and welcoming the Greek deal with international creditors, but flat-lined afterwards. US Treasuries moved in positive territory during US dealings on weak US car sales, weakness in oil prices (Brent tested key support around $50/barrel) and ahead of tonight s FOMC meeting. In a daily perspective, the German yield curve shifted 0.9 bps (30-yr) to 1.6 bps (5-yr) higher. The US yield curve dropped 1.6 bps (2-yr) to 3.8 bps (5y & 10y) lower. The belly of the curve outperformed the wings. On intra-emu bond markets, 10-yr yield spread changes versus Germany ranged between +1 bp (Portugal) and -3 bps (France/Belgium) with Greece outperforming (-37 bps). More US disappointing data? Today s eco calendar is interesting with the US ADP employment report (consensus: 175K), the non-manufacturing ISM (55.8 from 55.2) and the EMU Q1 GDP (expected 0.5% Q/Q & 1.7% Y/Y). After two exceptionally strong ADP reports, there is scope for some payback, just like the March payrolls did. Risks are t on the downside of expectations, though an Easter effect may distort the data. We see downside risks for the services ISM as well because of the disappointing manufacturing ISM, despite the low correlation. Risk towards the Q1 EMU GDP are balanced. Survey evidence pointed to stronger growth, but the hard data have been slightly disappointing, including the released French Q1 GDP. So, to reach the 0.5% Q/Q, a strong German GDP is needed. FOMC to stand put The FOMC will normally keep its policy rate unchanged (0.75%-1%). The market implied probability of a hike is only slightly above 10%. Coming on the heels of tightening in March, another hike would be unduly aggressive. We don t expect big changes to the policy statement neither. The Fed will keep the possibility of a June hike intact though (our favorite timing, with market probability of close to 70%). Several Fed governors are scheduled to speak later this week, which may give us a better take policy outlook. Q2 GDP should rebound following the disappointing 0.7% Q/Qa in Q1 while inflation already moved to the 2% threshold. The Fed will certainly continue the discussion on balance sheet tapering, but it s too early for a detailed action plan. We know that the Fed wants to start tapering this year and will do so initially via (partial?) non-re-investment of maturing assets (likely MBS, unlikely US Treasuries). Major questions are the ultimate size of the sheet ($2.5B as suggested by Bernanke?) and the pace of tapering. Markets will be sensitive to these issues, which might be tackled when Fed speakers appear Friday. Fed rate probabilities for today s meeting: blue (unchanged) & red (+25 bps): Markets not prepared for rate hike. Brent crude tests key support ($50/barrel area) ahead op API and EIA data. A decline in US inventories (API) prevented a break lower. P. 2

3 R2 163,99-1d R1 162,49 BUND 161,75 0,07 S1 158,73 S2 158,28 German Bund auction: no improvement expected The German Finanzagentur starts this week s scheduled EMU bond supply with a 10-yr Bund auction ( 3B 0.25% Feb2027). Total bids at the previous 4 Bund auctions averaged 3.97B. We don t expect much improvement today. The bond traded stable in ASW spread terms going into the auction, but is a tad cheap on the curve. Upward bias US Treasuries, outperforming Bunds Overnight, Asian equity markets trade mixed with China underperforming and Japan & North Korea closed. US equity futures (Nasdaq) suggest profit taking/disappointment on miscellaneous Apple earnings. The US Note future is stable, but the Bund could still open slightly higher. Today s eco calendar contains EMU Q1 GDP, US ADP employment report and non-manufacturing ISM. Risks for US eco data are on the downside of expectations. US stock markets might be prone for a correction lower based on futures trading. Oil prices arrived a key support levels (Brent crude $50/barrel) ahead of EIA data and are vulnerable for a downside break in case of high inventories. This combination suggests that US Treasuries could find support ahead of the FOMC meeting, outperforming Bunds. It s a tricky environment for the central bank. If the Fed doesn t manage to keep June rate hikes expectations near current levels (70%) eg by stressing weak Q1 GDP too much or referring to the continued need of strong eco data, the US Note future could even revisit the contract high short term. We would use such move to enter new short positions. Friday s avalanche on Fed speakers could correct a soft market reaction by confirming the intention to continue the gradual tightening pace, a similar scenario as between the February and March FOMC meetings. A hawkish Fed - clear reference to June tightening and/or balance sheet tapering -, not our preferred scenario, would trigger immediate selling. German Bund: Nice rebound on Draghi. Post French election gap probably needs to be closed before new downward action may occur. US Note future: Possibility to revisit contract high on mix of weak eco data, low oil prices, correcting stocks and a (too) cautious Fed statement? P. 3

4 Currencies Fed to decide on USD rebound USD/JPY: test of resistance blocked for now. EUR/USD holds near the recent correction top R2 1,13-1d R1 1,1145 EUR/USD 1,0924 0,0007 S1 1,0778 S2 1,0341 EUR/USD trading near recent top going into the Fed policy decision. Kiwi dollar fails to maintain gains after good labour data Interesting eco data, but markets will focus on FOMC policy decision No big changes in the policy statement are expected. Markets will look out for the assessment on the poor Q1 GDP growth. There were few eco data with potential to move the euro or the dollar yesterday. Especially EUR/USD held a tight range in the low 1.09 area. Greece s agreement with international creditors and hawkish comments of ECB Nowotny couldn t help the euro. Late in the session EUR/USD drifted slightly higher on USD softness to close the session at USD/JPY tried to regain resistance as risk sentiment remained constructive, but the pair returned to the 112 area as US yields lost a few bps later in the session. This move was at least partially driven by a decline of the oil price. Overnight, several Asian markets including Japan are closed for regional holidays. Mediocre earnings from Apple published after the close yesterday weigh on Asian sentiment. USD/JPY hovers in the 112 area. EUR/USD trades in the area. So, the recent highs are again within reach as investors count down to the Fed s policy decision. The New-Zealand employment/unemployment data were stronger than expected, but wage data remained relatively soft. The kiwi dollar initially gained modestly ground after the publication of the release, but most of the intraday gains already evaporated. NZD/USD trades again near Today s eco calendar contains the US ADP employment report (consensus: 175K), the non-manufacturing ISM (55.8 from 55.2) and the EMU Q1 GDP (expected 0.5% Q/Q & 1.7% Y/Y). After two exceptionally strong ADP reports, there is room for some payback. We see downside risks for the services ISM as well after a disappointing manufacturing ISM. Risk for the Q1 EMU GDP are balanced. a strong German GDP is needed to reach the 0.5% Q/Q, The FOMC is widely expected to keep its policy rate unchanged (0.75%-1%). In the Fed statement we don t expect a real policy shift. The statement will keep the possibility of a June hike (and another rate hike this year) intact. Will the Fed downplay Q1 growth? Later this week, the Fed governors will speak out, which may give us a better take on the outlook for policy. Q2 GDP should rebound and inflation moved already to the 2% threshold (if not in Q1 GDP deflator terms). The Fed most probably continues the discussion on balance sheet tapering, but it looks too early to already receive an action plan. Markets will be sensitive to these issues, but these might only be tackled when Fed speakers appear Friday. EUR/ USD: holding near the post-macron-top. Fed to decide on ST break higher? USD/JPY: gradual rebound continues, but first test of didn t succeed (yet?) In a daily perspective, the focus will be on the Fed statement. If the Fed elaborates on recent US data softness, it might be a slightly USD negative, even if the FOMC keeps the option of a June rate hike open. P. 4

5 The intraday developments/factors (EU and US data, soft oil price, modest equity correction?...) are probably also a slightly negative for the dollar. In this context, the Fed will have to sound quite convincing on its future rate hike intentions to support the dollar. We are not convinced that the dollar will get enough interest rate support right now. We don t expect a USD sell-off, but EUR/USD might test and even (temporary?) regain the area. In this context, it also won t be easy for USD/JPY to regain the area in a sustainable way. Last week, FX trading was driven by the risk trade as European event risk eased. This supported USD/JPY, but also EUR/USD and EUR/JPY. The market pondered whether declining political risk could bring forward the ECB s normalisation process. This hope was moderated after the ECB press conference. From a technical point of view, the rebound of USD/JPY suggests a bottoming out process has started, but the pair needs to regain the level (neckline ST double bottom) to improve the picture. A first test yesterday didn t succeed yet. EUR/USD extensively tested the topside of the MT range (1.0874/ area) late March. The pair returned to the range top after the French election and set minor new highs. We look out how this test turns out. If EUR/USD regains the 1.10 barrier, next resistance comes in in the /1.13 area (US pre/post-election swings). R2 0,8881-1d R1 0,8854 EUR/GBP 0,8470 0,0006 S1 0,8314 S2 0,8304 Sterling to become more sensitive for Brexit headlines? Yesterday, sterling remained under pressure early in Europe as the harsh comments from EU commission President Juncker on the Brexit negotiations continued to weigh on sterling. Mid-morning, the UK April manufacturing PMI came out surprisingly strong at 57.3 from 54.2 in March. Initially, the gains of sterling remained very modest, but the UK currency gradually received a better bid later in the session. EUR/GBP closed the session at Cable regained the 1.29 level and closed the session at Today, UK construction PMI is expected to decline slightly from 52.2 to This morning, sterling is again trading with a slight negative bias on Press headlines that the EU will take a tough stance on the UK financial obligations at the start of the Brexit negotiations. So, as was the case earlier this week, there are tentative signs that Brexit uncertainty is gradually becoming a bit more important for sterling trading. A more cautious sentiment on risk might also be slightly negative for sterling. On the other hand, EUR/GBP might be supported by some overall euro strength. Will this be enough for EUR/GBP return to the 0.85 barrier today? Two weeks ago, EUR/GBP dropped below EUR/GBP 0.84 support, (temporary) improving the sterling picture. The pair came within reach of the key support (Dec low), but no real test occurred. After last week s EUR/GBP rebound, the range bottom is better protected. Longer term, Brexit-complications remain potentially negative for sterling. On technical considerations we are inclined to reconsider a cautious EUR/GBP buy-on-dips approach. EUR/GBP: downside better protected after last week s rebound GBP/USD: tentative signs of a topping out process? P. 5

6 Calendar Wednesday, 3 May Consensus Previous US 14:15 ADP Employment Change (Apr) 175k 263k 15:45 Markit US Services PMI (Apr F) :45 Markit US Composite PMI (Apr F) :00 ISM Non-Manf. Composite (Apr) :00 FOMC Rate Decision (Lower/Upper Bound) 0.75%/1.00% 0.75%/1.00% UK 01:01 BRC Shop Price Index YoY (Apr) A: -0.5% -0.8% 10:30 Markit/CIPS UK Construction PMI (Apr) EMU 11:00 PPI MoM / YoY (Mar) -0.1%/4.2% 0.0%/4.5% 11:00 GDP SA QoQ / YoY (1Q A) 0.5%/1.7% 0.5%/1.7% Germany 09:55 Unemployment Change (000's) (Apr) -11k -30k 09:55 Unemployment Claims Rate SA (Apr) 5.8% 5.8% Spain 09:00 Unemployment MoM Net ('000s) (Apr) Events 11:30 Germany to Sell 3B 0.25% 2027 Bonds 13:00 ECB s Hansson Speaks to Estonian Lawmakers in Tallinn 10-year td -1d 2-year td -1d Stocks td -1d US 2,29-0,03 US 1,26-0,01 DOW 20949,89 36,43 DE 0,32 0,01 DE -0,72 0,02 NASDAQ 6095,366 3,76 BE 0,76-0,02 BE -0,54 0,01 NIKKEI 19445,7 0,00 UK 1,09 0,00 UK 0,08 0,00 DAX 12507,9 69,89 JP 0,02 0,00 JP -0,20 0,00 DJ euro ,21 18,62 IRS EUR USD GBP EUR -1d -2d USD td -1d 3y -0,05 1,72 0,63 Eonia -0,3560-0,0050 5y 0,19 1,94 0,80 Euribor-1-0,3740 0,0000 Libor-1 0,9950 0, y 0,79 2,25 1,16 Euribor-3-0,3290 0,0000 Libor-3 1,1723 0,0000 Euribor-6-0,2490 0,0000 Libor-6 1,4263 0,0000 Currencies td -1d Currencies td -1d Commodities td -1d EUR/USD 1,0924 0,0007 EUR/JPY 122,53 0,16 CRB 180,34-1,25 USD/JPY 112,15 0,09 EUR/GBP 0,8470 0,0006 Gold 1256,60 0,00 GBP/USD 1,2897-0,0003 EUR/CHF 1,0833-0,0037 Brent 50,88-0,48 AUD/USD 0,7493-0,0042 EUR/SEK 9,6265-0,0311 USD/CAD 1,3737 0,0062 EUR/NOK 9,3927 0,0024 P. 6

7 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