Yesterday, the US Treasury held an auction of 10-year bonds offering $23B of them. Let me remind you that the US bond auction events should be closely monitored, since the bond supply is rising (to raise money for tax reform), while rate hikes and economic growth negatively affect demand in terms of yield and in terms of appetite to risk.

Yield to maturity came at 2.957%, slightly below the 3% which I mentioned in the past review. Investors asked for a yield which was slightly lower than it was at the auction last month (2.96%). Inside the auction, the bid-to-cover ratio was at 2.58 (2.55 in August), indicating a consistently high appetite, the percentage of indirect buyers was 64% against 61.3% in August and higher than the average of six months (60.8%), dealers took 22.6% of securities and the remaining 13.4% fell on direct buyers.

10YR US government bond yield

Overall, the placement was quite successful compared to auction of 3-year bonds, held on Tuesday, most likely due to the fact that 10-year securities were absorbed well in August (when the yield dropped from 3% to 2.8%). The following placements, which are likely to take place with yields above 3%, will most likely start showing signs of weakness in demand.

10YR auction data

ECB meeting

What is known from the last meeting:

⁃ The rates are expected to remain at current levels at least until the summer of 2019, the rational duration of such a policy depends on the time that inflation needs to reach 2% in the medium term;

⁃ If trends in economic data develop in the right direction, the volume of asset purchases will be reduced to 15 billion euros in September, and the asset-purchase program will stop at the end of the year.

⁃ The risks for the euro area remain broadly balanced. The move to protectionism, as the main challenge to world trade, remains a matter of concern. Volatility in financial markets requires close monitoring.

⁃ Inflation remains on the necessary trajectory and will remain after the completion of the QE, but for this it is required to adhere to other monetary measures to support the economy (low rates).

The data received after the July meeting:

GDP for the second quarter increased by 0.4% with a forecast of 0.5%, annual economic growth slowed to 2.1%, although 2.5% was expected. On the inflation front, core inflation rose by 1.1% in July, the highest level since September 2017, but already in August, it slowed to 1%, not living up to the forecasts. In general, the development of inflation does not allow us to take the ECB as a hawkish position, since attempting to not rely on stimulus, and therefore suggesting the presence of another source of pressure in prices, is not yet possible. Among other data, shifting the growth toward slowdown, we can note PMI for July and August without positive shifts, the strengthening of the euro against the dollar. The reason for the enthusiasm, however, may be the changes in wage growth, which rose to 2.2% in second quarter.

Possible changes in the forward guidance at the meeting today:

⁃ It is unlikely that the ECB will be generous enough to give more clues on the rate hike timeframe, as it is not easy for ECB to remain bold in policy steps without understanding how the next stage of cutting down asset-purchase will affect the economy. The situation of the Fed with the US economy is very different from what the ECB has to work with, and the tariffs did not particularly affect European prices. It also makes no sense to drop a bullish hint for the euro buyers, which the ECB also relies on as a supporting factor.

⁃ It makes even less sense to make any changes in the pace of cuts of the asset purchase program, so in this part of the statement, we are not expecting anything new. An unlikely comment about a rollback in purchases can be imagined but only if there is a severe downturn on the horizon which off course can throw off the ECB’s plans, but it’s highly unlikely.

⁃ The ECB is likely to lower the GDP forecast, and may again refer to the risks of trade tensions, but in the context of the influence of these factors on future policy, their significance may be downgraded by the market to “on-duty” wordings.

Just in case, I would like to mention bearish and bullish surprises, and what they may lead to.

Lower inflation forecasts, or hints about extension of the purchase of assets for 2019, will provoke a significant decline in the euro, to the level of 1.14 – 1.13.

On the other hand, if the ECB reports “even greater confidence” in inflation, a firm belief in the need to complete QE in 2018, it will lead to the EURUSD rally at least to 1.18

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

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