European bonds slide on Fed rate hike expectations

The European bonds slumped on Wednesday, lifted by a rise in U.S. Treasury yields after data and hawkish comments from Federal Reserve officials boosted expectations for a U.S. interest rate rise this year. The benchmark German 10-year bonds yield, which is inversely proportional to bond price rose 1bp 0.144 pct, French 10-year bunds yield jumped 2bps to 0.492 pct, Irish equivalents inched higher 2bps to 0.825 pct, Spanish 10-year bonds yield climbed 1bp to 1.574 pct, Netherlands 10-year bonds yield rose 1bp at 0.368 pct, British 10-year bonds yield rose 2bps to 1.392 pct by 0845 GMT.

The U.S consumer price index (CPI) increased 0.4 pct m/m, above expectations for a 0.3 pct m/m, from the unrevised 0.1 pct m/m result that occurred in March. Meanwhile, core CPI came in +0.2% m/m in April, in the line with expectations for a 0.2 pct m/m increase as compared to unrevised 0.1 pct m/m reading seen in March. Despite the overall dampness seen in recent months, we expect a gradual pick-up in inflation readings will be seen in the months ahead. However, we are unlikely to see a substantial move towards the Fed's 2 percent objective until we see greater traction from wage pressures. Moreover, the April Commerce Department housing starts and building permits report registered an increase in housing starts to 1172k, which rose 6.6 pct m/m, well above market expectations for a 1135k, from the revised 1099k reading seen in March (previous 1089k). Meanwhile, building permits rose 3.6 pct m/m to 1116k in April, below market expectations for a 1130k result, as compared to the revised 1077k reading that occurred in March (prev. 1086k). Alongside the increase seen in starts, we expect broader improvement is likely to be seen in the months ahead as production gradually improves, despite any lingering headwinds.

In addition, the Dallas Fed President Kaplan said that he sees the US economy strong enough to justify a rate hike in the not too distant future. Kaplan noted that the Fed wants to normalize rates but due to global headwinds there is limit to how fast they can go. It is relatively hawkish commentary from the non-voter. Although we see rates moving higher in the second half of 2016 we are reluctant to buy into the notion that the FOMC as a whole is pushing to raise rates, particularly given the dovish tone set by the April statement. Similarly, San Francisco Fed President Williams said that the data to his mind are lining up to make a good case for rate increases in the next few meetings, not just June, which means it’s very live in terms of that, adding that if we stay on the good path which we’re on, then if we were to raise two or three times this year it wouldn’t be that much of a surprise.

Moreover, the European bonds have been closely following developments in oil markets because of their impact on inflation expectations, which are well below the European Central Bank's target. Today, crude oil prices tumbled on profit booking and surging dollar, but hovering at record high of $49 per barrel after the American Petroleum Institute reported that U.S. crude supplies fell by 1.1 million barrels for the week ended May 13. Reuters in its recent report said that supply disruptions from Nigeria, Venezuela, the United States and China triggered a U-turn in the oil outlook of Goldman Sachs, which long warned of overflowing storage and another looming crash in prices. Venezuela's oil production has already fallen by at least 188,000 barrel per day (bpd) since the start of the year as PDVSA struggles to make the investment needed to keep output steady. In the United States, crude production has fallen to 8.8 million bpd, 8.4 pct below 2015 peaks as the sector suffers a wave of bankruptcies. And in China, output fell 5.6 pct to 4.04 million bpd in April, compared with the same time last year. Meanwhile, the International benchmark Brent futures fell 0.53 pct to $49.03 and West Texas Intermediate (WTI) dipped 0.27 pct to $48.18 by 0900 GMT.

Meanwhile, the pan-European STOXX 600 index was down 0.27 pct and the euro-area blue-chip gauge, the STOXX 50 dipped 0.04 pct. The FTSE 100 Index down 0.39 pct, the DAX trading 0.22 pct lower and the CAC-40 fell 0.23 pct by 0900 GMT.