Asymmetric yield response to US elections

The risk-on mood that prevailed yesterday belies the uncertainty that is still present in tonight’s US presidential election. We believe that a Clinton win would see 10yr Treasury yields climbing somewhat higher, although we draw a line at 2% – our expectation for the terminal rate for the fed funds rate. To be sure, a major risk-off move in the wake of a Trump victory is likely to drive down the UST 10yr yield by least 25bp.

While 10yr Bunds stuck close to 0.15% amidst low volumes, intra-EMU spreads displayed a notable tightening yesterday. While a tentative risk-on was prevalent, idiosyncratic country stories added to the tightening. The 10yr PGB-Bund spread narrowed by more than 7bp as the Portuguese parliament passed the 2017 budget. Moreover, while still tightening vs Bunds, SPGBs lagged behind BTPs as Moody’s warned that Spain’s minority government was “credit negative” for the country.

In line with last year’s practice, the ECB yesterday announced to suspend QE purchases over Christmas and year-end due to low liquidity. Purchases would be front loaded into the first three weeks of December. However, frontloading is already well underway. Overall ECB QE purchases amounted to €85.4bn in October – €5.4bn over the monthly target. This leaves the ECB with a buffer over the accumulated target amount of €13bn already. The ECB’s latest set of detailed monthly PSPP data revealed that the ECB continues to purchase relatively more in the larger markets to compensate for shortfalls versus country targets in the smaller countries. Still, the Bundesbank was able to shorten the average maturity of its (monthly) purchases to below 11 years which ties in with generally higher yields also at the shorter end of the curve.

 Germany will re-open the DBRI 0.1 4/26 for €0.5bn today. Elsewhere, the DSTA will reopen the DSL 0.5 7/26 for a targeted amount of €1.5-2.5bn. This will be the last tap of the year and the final re-opening of this line as the outstanding amount will reach the €15bn target. Despite the richening since end October, the roll versus the DSL 7/25’s at 13bp remains close to the upper end of its historic trading range. This also more or less applies to the pick-up over the DBR 8/26, which, at around 11bp, still offers decent compensation for any liquidity premium that exists versus Bunds. Do note though that the Dutch 10yr benchmark did not trade special in repo yesterday, while the DBR 0 8/26 traded almost 50bp below GC.

The 10yr sector of has shown a clear underperformance on the DSL curve over the past week (yesterday notwithstanding). On the fly versus the 5yr DSL 1/22 and the older DSL 2.5 1/33 line, the to-be-tapped benchmark still looks attractive indeed. This is partly due to the steepening of the 5s10s, but also reflects the 10s15s having lagged behind the steepening of the 10s30s. The possibility of the ECB increasing the issue share limit for non-CAC bonds from the current 33% in December – which could support the 1/33 line – and relaxing the depo rate floor for PSPP purchases – which may support shorter dated lines including the 5yr –could well cheapen the 10yr further on the fly. However, the QEinduced discount for relatively young benchmark lines such as the DSL 7/26 should fade as it reaches its target size. Moreover, the DSTA looks set to re-open older lines including the 1/33 (which has an outstanding size of €12.5bn) next year. In this context, please note that next year’s total DSL issuance is likely to come in close to €40bn, well above the €26bn printed this year