The FED and Global Bond Markets, European Supply

The Fed clearly telegraphed they remain on track to hike rates in December, but failed to give any definitive signal in the statement. Indeed, they refrained from repeating the “appropriate to hike at the next meeting” language from the meeting prior to the December 2015 rate hike. Nonetheless, the market-implied probability of a December hike, at 78%, is now much higher than at the same time last year (i.e. 50%). So long as next week’s election outcome does not trigger market turmoil and/or the data do not take a dramatic turn for the worse, the December meeting indeed looks to be “the one”. UST 2yr yields closed 1.5bp lower at 0.82%, while the Fed funds futures curve (FF1– FF12) flattened to slightly below 30bp – suggesting investors expect at most two hikes from the Fed over the next 12 months. Interestingly, the 2/5/10yr fly valuation continues to reflect a scepticism amongst investors on whether the Fed will pull even this off.

EGB supply. Today France will reopen the FRTRs 11/26 and 5/36 (€7-8bn). The 10yr yield spread versus Bunds has widened to c. 32bp, thus just short of the previous peak in early October. Going into the auctions OATs have started to perform versus OLOs in the past few days, suggesting part of the earlier underperformance was owed to pre-auction concessions. The FRTR 11/26 yields 6.5bp more than the BGB 6/26 (1.8bp in z-spreads). Note that the 10yr benchmark in particular has been trading very special in repo lately.

Spain will reopen the 5yr SPGB 7/21, 10yr SPGB 10/26 and 15yr SPGB 7/30 (€2.5- 3.5bn) alongside the 10yr linker SPGBEI 11/24 (€0.5-1bn). The end to the political deadlock has benefitted SPGBs over the past weeks, but 10yr spreads versus Bunds have run into resistance at around 105bp. A new government is one thing, but passing a budget with a minority government is another. Furthermore, Catalan independence ambitions could move back into focus again, where unilateral action by the Catalan regional government around mid-2017 cannot be excluded. On balance, we think SPGBs look relatively rich by now, not only versus BTPs. Elsewhere, Ireland will tap the IRISH 5/30 (€0.75bn), which could well be the last auction for the year. Issuance to date has reached €7.6bn already and will move to the upper half of the NTMA’s envisaged €6- 10bn target range after today.