Since I upgraded my tactical outlook back to bullish again and brought it in line with my strategic view (see Rates Strategy: Relaxed and ready to move dated August 14), the Bund future has broken trough its July 8 high. However, over the past days the performance has been much more muted and essentially it traded in a tight range with a small upward bias. On the other side, 10y US Treasuries have over the past two weeks outperformed, gaining some 10bp relative to 10y Bunds, but the 10y TNote future is still trading half a point below its July 10 high. It might well be that USTs cheapen into next week's supply, but other than that I do not yet see good reasons to change my bullish tactical outlook and stick with it.
For one, the inflation outlook remains supportive of government bonds. As written yesterday, a key feature of US inflation developments is the significant disinflation in the core services CPI, bringing it down to a record post-WWII low. With the output gap continuing to grow and CPI being a lagging indicator, inflation in the US (and the Eurozone) does not promise to resurface soon on any meaningful degree.
Secondly, I continue to believe that growth in final demand will remain muted for a prolonged period of time amid high unemployment, limited wage growth, a negative wealth effect and the need to restore savings. In this respect I still expect the rally in risky assets to falter with prices moving markedly lower during autumn and into winter.
Furthermore, the technical picture in 10y USTs looks supportive as well. As the chart below shows, the 10y UST yield has broken through its upward trendline which guided trading all of this year.
Finally, overall positioning by non-commercial investors into US bond futures remains tilted towards the short side (positioning is long in 2y and 5y futures, but short in 10y and 30y).
The supply next week might well be anticipated with some price concessions, however, I would regard this as temporary only and stick to tactical longs.