Core bonds gained modest ground today in another low-volume trading session ahead of tonight’s FOMC meeting (see below). European stock markets turned south on mixed Chinese trade news, new brexit hurdles and individual problems (eg Bayer & BMW) with core bonds benefiting from some safe haven flows. US yields shed 1.2 bps (2-yr) to 2 bps (10-yr) in a daily perspective. Changes on the German yield curve vary between +0.3 bps (2-yr) and -1.1 bp (30-yr). Peripheral yield spreads vs Germany widen by 3 to 5 bps.

Today’s UK CPI data were of no importance for sterling whatsoever. With just 9 days on the counter before the UK is to leave the European bloc, Brexit is all that matters to investors. An extension looks inevitable however, as PM Theresa May failed to push her brexitdeal through Parliament twice and was banned from giving the same deal a third try earlier this week. May thus formally requested the EU this morning to postpone Brexit with three months, up until June 30. Markets weren’t expecting the proposed extension to be this short. May repeatedly warned that if her deal didn’t get approved she would have to ask for more than just a technical (three month) delay. The EU however suggests either a short(er) extension, before May 23 (European election day) or a much longer one (at least until the end of the year). The first requires May to strike a refurbished brexitdeal and pass it through Parliament in two months’ time. That is highly improbable and a no-deal scenario would then likely be the result. A long extension is a no-go for May since that would leave all options open, including a 2nd referendum, elections or even no Brexit at all. It also poses legal threats regarding the European elections and whether the UK can/should participate or not. The EU will discuss May’s request during a Summit starting tomorrow. The huge amount of uncertainty is weighing on sterling today. Cable slipped back below the 1.32-handle (-0.65%). EUR/GBP strengthens almost 1%, regaining the 0.86-mark (0.862 currently) and causing some spill overs in EUR/USD. The pair edges higher during an otherwise eventless trading session and changes hands close to 1.136. Moves remain extremely limited however as investors are awaiting tonight’s Fed meeting before taking any directional dollar positions.

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Fed chair Powell already suggested in front of US Congress to halt the balance sheet run-off by the end of the year. That’s much sooner than the Fed originally had in mind and market participants had expected until the turn of last year. Communication on the composition of the Fed’s portfolio is a wildcard. The Fed might eg opt to continue to let its MBS-portfolio run off, but replace them by US Treasuries. Another factor the Fed might tweak is the duration of its Treasury portfolio. Shortening it would be considered hawkish and vice versa. Apart from this, we expect the Fed’s plotted rate hikes to drop from 3 currently (2 in 2019 and 1 in 2020) to 1 (in 2019) taking into account weaker growth and inflation forecasts. The Fed’s feared inflation overshoot didn’t happen last year, putting governors at ease to take a more wait-and-see approach as the economy shows first signs of sputtering. Markets remain even softer positioned with unchanged rates this year and a rate cut in 2020.

News Headlines

UK February consumer inflation came in close to expectations. Headline inflation accelerated to 1.9% YoY (0.5% MoM) vs. 1.8% (0.4% MoM) expected. Core measures showed prices increasing at 1.8% YoY, down from 1.9% in January and slightly below estimates. Housing prices advanced at the slowest pace since mid-2013 (1.7%, 2.4% expected).

Germany plans to create a state-owned fund by the end of 2019 that can be used to protect key companies from foreign (Chinese) takeovers. The idea has been launched in February as part of the country’s new industrial strategy and is now being put in draft laws.


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