Bonds: 10-year gilt yield flat before UK GDP

These were the movements in some of the most widely followed 10-year sovereign bond yields:

US: 2.62% (+0bp)

UK: 1.41% (+1bp)

Germany: 0.61% (+2bp)

France: 0.88% (+3bp)

Spain 1.40% (+5bp)

Italy: 1.95% (+6bp)

Portugal: 1.88% (+0bp)

Greece: 3.66% (-1bp)

Japan: 0.07% (-1bp)

Eurozone yields rose after the European Central Bank (ECB) President Mario Draghi delivered an upbeat statement following the bank’s policy decision on Thursday.

Draghi was confident that the euro-area inflation will improve due to the combination of internal and external factors.

The euro ticked higher to $1.2537, a fresh three-year high, against the US dollar.

Yet, the ECB’s cautious approach on interest rates dented the euro-bulls’ appetite. The single currency returned below $1.25, as Draghi said he sees ‘very few chances’ that the policy rates will be raised this year. The pair extended losses to $1.2370 in Asia.

The 10-year Bund yield closed 2 basis points (bps) higher at 0.61% on Thursday. The 10-year Spanish and Italian yields surged by 5bps and 6bps respectively. The exception was the yield on 10-year Greek government bond, which eased 1bp to 3.66%.

In summary, the ECB refrained from changing its language on forward guidance to focus less on asset purchases at the January meeting.

In contrary, several members preferred to delay a significant hawkish shift in the communiqué until June.

More importantly, Draghi warned that the volatility in the currency market is a ‘source of uncertainty’, which needs to be monitored closely.

Similar comment in ECB’s September statement had encouraged a downside correction in the Eurozone sovereign yields and the euro.

In the UK, the 10-year gilt yield consolidated near 1.41%. The pound pared gains after hitting $1.4345 versus the US dollar, a fresh high since the UK decided to exit the European Union on June 23, 2016.

Meanwhile in bonds, 10y Treasuries closed 3.3bps higher at 2.647% while long-dated 30y bonds were also 3.4bps higher at 2.929%. Yields in Europe were a few basis points higher while Gilts sold-off 5.4bps to hit the highest since February 2017. Gold (+1.29%) seemed to be the big beneficiary of the bond move.

The UK’s fourth quarter gross domestic product (GDP) data is due Friday. GDP is forecast to have grown at a 0.4% quarter-on-quarter clip, though there were many economists predicting the rate will have slowed 0.3% from the 0.4% seen in the third quarter.

According to the consensus of analyst expectations, British GDP growth may have eased to 1.4% year-on-year from 1.7% printed a month earlier.

With manufacturing gaining momentum and the service sector rising 0.2% month-on-month in October, outweighing the shutdown in the Forties oil and gas field in December, HSBC said this suggested GDP growth maintained its pace at 0.4%.

"The UK economy has lost momentum over the last year, and despite no further slowdown in quarter-on-quarter growth, this will take its toll on the year-on-year comparison in Q4: we expect this to drop from 1.7% to 1.4%," the bank said.

On the other hand, the index of services may have improved to 0.3% in the three months to November, from 0.4% previously.

"How the MPC views the GDP data will depend on whether it sees the rise in demand soaking up some of the remaining spare capacity in the economy," according to analysts at Bloomberg Economics.

If the slack in the economy persists, the Bank of England will likely keep the interest rates unchanged until 2019.

The US dollar index rebounded as much as 1.3% from a three-year low of 88.438, after the US President Donald Trump revealed his preference for strong US dollar in an interview at the World Economic Forum in Davos.

His comments came a day after US Secretary of Treasury Steven Mnuchin endorsed a weaker US dollar.

The US 10-year government bond yield recovered as much as five basis points to 2.6745% on Thursday, before diving to 2.6150%.

Moving forward, investors' focus will shift to the Federal Reserve decision due next week.

"As central banks step back from supporting financial markets, we expect to see more bond market volatility in 2018’ wrote David Absolon, investment director at Heartwood Investment Management. "Shorter-dated US treasury yields had already moved meaningfully in the final quarter of 2017, but longer-dated bonds were still fixated to the low interest rate and low inflation backdrop. Evidently this view is now shifting, and we believe that our long-standing underweight duration position in developed sovereign markets remains the most prudent stance."

European government bond supply next week is scheduled from Italy estimated at €8bn, Germany with €4bn, France around €8bn and Spain at €4.2bn.

There are €12.8bn of coupons and €41.4bn of redemptions from Italy and Spain that are eligible for reinvestment next week and no US Treasury supply next week, noted Citi analysts, looking at $7bn of coupons and $104.5bn of redemptions that are eligible for reinvestment next week but no gilt supply next week. There are no gilt cash flows eligible for reinvestment next week.

By Ipek Ozkardeskaya