Global Yield Curves, Bonds and Inflation Linkers

Sovereigns and Supply

The highest conviction short remains in Europe, where the scores for both Bunds and gilts havea reasonably high conviction 4-handle.The UST signal is only slightly outsidethe-1.5/+1.5 neutral threshold, and could easily slip back to neutral next week. The JGB signal is more negative, but we have been inclined to ignore it given the BoJ’s extraordinary yield curve management policy.

In the euro area, the recent outperformance of France has been partly reflected by the cheapness of BTPs but is also dueto the favorable October seasonality. We keep our position on 10s30s OATflattener vs Bund to explore the relative cheapness of the 30yr OAT-Bund. We estimate the indexextension for the broad euro government bond to be 0.1y, in line with average October extension. In Japan, we have the 20y JGB auction Tuesday and suggest buying 20y JGBs outright at the auction or against selling 10y JGBs.

The main reason for the more bearish output is more negative momentum (with the exception of JGBs, G4 yields are notably higher than they were a month ago) and also better risky asset performance, in particular EM equity markets, which have continued to eke out gains even as the DM equity rally has petered out. The main reason for the more bearish signal for European markets is better-than-expected growth data, which challenges expectations of further central bank easing.

It is worth noting that the market has moderated its rate cut expectations for both the ECB and MPC, but what matters more for Bunds and gilts is how much the current QE programmes are extended. President Draghi gave little away on this topic at this week’s ECB meeting; there is a risk the MPC delays announcing an extension of the APF until next February.

The Fed will have important incoming data to digest on Friday, October 28.Theemployment cost index (ECI) for 3Q16 and the advance report for 3Q16 real GDP growth will either confirm, or throw into question, the Fed’s projections for the economy and views about labor market slack in the second half of the year. Therefore, if 3Q16 growth comes in below 2.5%, we suspect the median participant will be disappointed, but not discouraged. We think growth at >=2.0% will keep the Fed’s narrative alive- that narrative involving a pickup in growth from 1H to 2H. Growth in 2H only has to average 2.5% to meet the median participant’s projection for the full year.


 In the US,TIPS performance has reflected positive sentiment, even though we do not see supportive fundamentals. We stay neutral on outright break evens, but suggest 5s30s breakeven curve steepener as an asymmetric play for lower break evens. We looked at surprises in core CPI and how they impact breakeven performance with a lag. We also examine the outlook and drivers of core goods prices from China. In the UK, given renewed GBP depreciation, we still see value in frontend UKTi breakevens