Market recap and ECB comments from IFR

Markit Manufacturing PMI missed expectations,50 vs f/c 51. New home sales Missed consensus but still withing 1 standard deviation of expectations.U.S. 5 year auction tailed by 1 bps showed a bid to cover trending below the last 5 average.ECB meeting tomorrow should provide some volatility as all sorts of outcomes could come from ECB.FAcebook earnings after close stock little changed

ECB preview from IFR

Without QE then, it looks like Bunds are priced for a very dovish ECB on top of the rate cut expectations. Our ECB-watcher, Divyang Shah is indeed looking for an all-round dovish package. He expects the ECB to cut the deposit rate by 10bp. He also expects the forward guidance to be changed in three ways, which will also leave the door open for more action in September, if needed.

First would be to bias the wording on rates themselves to “unchanged or lower” from “unchanged”. Next would be an extension to the current period over which that would apply from the middle of next year to the end of it. The third change Divyang envisages is a change in the state-contingent language so that the criteria for “sustained adjustment” are consistent with “convergence, confidence and resilience”. [Full report nL8N24P5FD]

Taken as a whole, and given that it might imply further action at the September meeting, a package along these lines should not engender too much disappointment and could even drive a rally. But anything short of this might deflate the market somewhat, and probably via the longer maturities.

Speaking of which, the 30y part of the curve has now flattened back to a more reasonable level, given the move in the 10y part of the curve. The 30y has, on a strong correlation to the 10y, moved consistently 1.2bp for every 1bp of 10y. This is of course part of the mechanics of bull flattening that has taken place for most of this year.

But there have been several occasions recently where the 30y has lagged a move in the 10y. This morning was one of them. At one point, the 10y yield had moved 3.4bp lower on the day, but the 30y yield had moved only 3.5bp lower. To be consistent with its beta, it should have moved 4.1bp. That came on top of divergence that (by this measure) has been building up for a few days now, implying a relative cheapness in the 30y of 4bp or so. A lot of that has now reversed this afternoon, such that the 30y is now only 2.5bp cheap to the 10y.

As this seems to have happened a lot in the past few weeks, it is almost as if market participants are pricing the 30y off the 10y, but are initially unsure about where to place it. There could be trading opportunities as a result for those quick off the mark on volatile days (which might include tomorrow).

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